UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549


FORM
10-K




[X]ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
 For the
fiscal year ended December 31, 2007









Commission
File No: 000-49844








TEMECULA
VALLEY BANCORP INC.


(Exact
name of registrant as specified in its charter)





California                                                                                    46-0476193


(State
or other jurisdiction of Incorporation or
organization)                                                                                                                              (I.R.S.
Employer identification No.)


27710
Jefferson Avenue – Suite A100, Temecula
CA                                                           92590


(Address
of principal executive
offices)                                                                                                                     (Zip Code)





Registrant’s
telephone number, including area code:


(951)
694-9940





Securities
registered pursuant to section 12(b) of the Act:


Title of
Each
Class                                                                             Name of Each Exchange
on which Registered


Common
Stock, No Par
Value                                                                                                                      NASDAQ





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.


Yes [
]          No [X]


Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.


Yes [
]          No [X]





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





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





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange
Act.


Large
accelerated filer [
]          Accelerated
Filer [X]        Non-accelerated
Filer []            Smaller
reporting company [ ]





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


Yes [
]   No [X]





The
aggregate market value of the common stock held by non-affiliates of the
Registrant as of June 30, 2007 was approximately $188,624,437 (based on the June
29, 2007 closing price of common stock of $17.69 per share).





Number of
Registrant’s shares of common stock outstanding at March 14, 2008 was
10,063,267.





Documents
incorporated by reference: Definitive Proxy Statement for the Annual Meeting of
Shareholders-Part III.





TABLE
OF CONTENTS


PAGEPART I
              
              4ITEM 1
              BUSINESS
              4ITEM 1A
              RISK FACTORS
              24ITEM 1B
              UNRESOLVED STAFF COMMENTS
              28ITEM 2
              PROPERTIES
              28ITEM 3
              LEGAL PROCEEDINGS
              28ITEM 4
              SUBMISSION OF MATTERS TO A VOTE OF SECURITY
      HOLDERS
              29PART II
              
              29ITEM 5
              MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED SHAREHOLDER
      MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
              29ITEM 6
              SELECTED FINANCIAL DATA
              33ITEM 7
              MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
      AND RESULTS OF OPERATIONS
              36ITEM 7A
              QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK
              50ITEM 8
              FINANCIAL STATEMENTS AND SUPPLEMENTAL
    DATA
              51ITEM 9
              CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
      AND FINANCIAL DISCLOSURE
              51ITEM 9A
              CONTROLS AND PROCEDURES
              51ITEM 9B
              OTHER INFORMATION
              52PART III
              
              52ITEM 10
              DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE
      GOVERNANCE
              52ITEM 11
              EXECUTIVE COMPENSATION
              52ITEM 12
              SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
      MANAGEMENT AND RELATED STOCKHOLDER MATTERS
              52ITEM 13
              CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND
      DIRECTOR INDEPENDENCE
              52ITEM 14
              PRINCIPAL ACCOUNTING FEES AND SERVICES
              53PART IV
              
              53ITEM 15
              EXHIBITS AND FINANCIAL STATEMENT
    SCHEDULES
              53SIGNATURES
              54REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
      FIRM
              55CONSOLIDATED FINANCIAL STATEMENTS
              56NOTES TO THE CONSOLIDATED FINANCIAL
      STATEMENTS
              60INDEX TO EXHIBITS
              79


CAUTIONARY
STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995





We have made forward-looking statements
in this document that are subject to risks and uncertainties. These statements
are based on the beliefs and assumptions of our management, and on information
currently available to our management. Forward-looking statements include the
information concerning our possible or assumed future results of operations, and
statements preceded by, followed by, or that include the words "will”,
"believes”, "expects”, "anticipates”, "intends”, "plans”, "estimates" or similar
expressions. Our management believes these forward-looking statements are
reasonable. However, you should not place undue reliance on the forward-looking
statements, since they are based on current expectations. Actual results may
differ materially from those currently expected or anticipated.





Forward-looking statements are not
guarantees of performance. They involve risks, uncertainties and assumptions.
Our future results and shareholder values may differ materially from those
expressed in these forward-looking statements. Many of the factors described
below, that will determine these results and values, are beyond our ability to
control or predict. For those statements, we claim the protection of the safe
harbor contained in the Private Securities Litigation Reform Act of
1995.





A number
of factors, some of which are beyond our ability to predict or control, could
cause future results to differ materially from those contemplated. These factors
include but are not limited to:





·
            a
      further slowdown in the national and California
  economies


·
            volatility
      of rate sensitive deposits


·
            changes
      in the regulatory environment


·
            increasing
      competitive pressure in the banking
industry


·
            operational
      risks including data processing system failures or
  fraud


·
            asset/liability
      matching risks and liquidity risks


·
            changes
      in the securities markets


·
            change
      in loan prepayment speeds





The
consequences of these factors, any of which could hurt our business, could
include, among others:





·
            increased
      loan delinquencies


·
            an
      escalation in problem assets and
foreclosures


·
            a
      decline in demand for our products and
services


·
            a
      reduction in the value of the collateral for loans made by us, especially
      real estate, which, in turn would likely reduce our customers’ borrowing
      power and the value of assets and collateral associated with our existing
      loans


·
            a
      reduction in the value of certain assets held by our
    company





See also
“Item 1A Risk Factors” and other risk factors discussed elsewhere in this Annual
Report.





3


PART I





ITEM
1:                      BUSINESS





General





Temecula
Valley Bancorp Inc.





We formed
Temecula Valley Bancorp Inc. ("company" or “our company” or “our holding
company”) in 2002 to serve as a holding company for Temecula Valley Bank ("bank"
or “our bank”). We reincorporated our holding company from Delaware into
California in December 2003 as a tax savings measure. Our holding company is a
bank holding company registered with the Board of Governors of the Federal
Reserve System ("Federal Reserve") under the Bank Holding Company Act of 1956,
as amended ("BHCA"). Our holding company’s activities consist of owning the
outstanding common stock of our bank, Temecula Valley Statutory Trust II,
Temecula Valley Statutory Trust III, Temecula Valley Statutory Trust IV,
Temecula Valley Statutory Trust V, and Temecula Valley Statutory Trust VI (as of
January 17, 2008). Unless the context indicates otherwise, all references in
this report to “we”, “us”, and “our” refer to our company and our bank on a
consolidated basis.





Temecula
Valley Bank





Our bank was organized in 1996 and
commenced operations on December 16, 1996 as a national banking association. Our
bank converted from a national charter to a state charter on June 29, 2005 to
take advantage of higher legal lending limits and reduced examination fees. The
deposits of our bank are insured by the Federal Deposit Insurance Corporation
("FDIC") up to the applicable limits. Our bank has no subsidiaries.





General
Business





Our bank currently has eleven
full-service banking offices in California providing services to customers in
the Riverside, San Bernardino, and San Diego Counties. Our principal office is
located in Temecula, California with other California full-service offices in
Carlsbad, Corona, El Cajon, Escondido, Fallbrook, Murrieta, Ontario, Solana
Beach, San Marcos, and in the Rancho Bernardo area of San Diego.





Our bank also operates loan production
offices which principally generate construction and/or mortgage loans in
California at the following locations: Encinitas, Fallbrook, Ontario, and
Temecula. The Real Estate Industries Group of our bank focuses on construction
lending and maintains loan production offices in Corona and San Rafael, both in
California. Our bank also has SBA loan production offices in the following
states: Arizona, California, Florida, Nevada, Oregon, and Texas.





Our holding company, as the parent of
our bank, has no operations and conducts no business of its own other than
owning the common shares of our bank, Temecula Valley Statutory Trust II,
Temecula Valley Statutory Trust III, Temecula Valley Statutory Trust IV,
Temecula Valley Statutory Trust V, and Temecula Valley Statutory Trust VI (as of
January 17, 2008) . Accordingly, the discussion of the business which follows
concerns the business conducted by our bank, unless otherwise indicated. No
material portion of our company’s business is seasonal.





Our
income is generally derived from interest on various loan products, income
generated on the sale of loans, and fees earned from servicing loans and from
providing deposit and other services. Our significant operating expenses are
interest paid on deposits, salaries and expenses of our employees and other
operating expenses such as rent.





Business
Strategy





Our goals
are to build a leading Southern California regional community banking franchise
designed to maximize long-term returns to our shareholders by seeking to grow
assets, while maintaining strong earnings. In order to achieve these goals, we
intend to pursue a strategy that takes advantage of and enhances our three core
business lines: community banking, construction lending and SBA lending.
Specifically, our strategy relies upon our ability to continue:





Attracting Talented &
Experienced Management. We have created an entrepreneurial culture with
performance-based compensation that attracts highly skilled bankers. Rather than
a traditional banking model of opening branches in a market followed by
staffing, we expand into new markets upon hiring bankers with histories of
successful business production and/or customer relationship management in our
area.


4


Expanding our Community Banking
Model. We have built and are expanding teams to provide a one-on-one
banking relationship with our customers. By providing superior service and a
wide range of loan and deposit products to our customers, we can expand our
business with existing customers and build a reputation that will attract
additional customers. We have built a cash management team devoted exclusively
to the development and implementation of state of the art products designed to
allow us to generate a higher level of core deposits from existing customers and
serve new deposit customers within our markets.





We opened
one new branch in 2005, two branches in 2006, and one branch in 2007. We will
continue to explore branch expansion opportunities as skilled bankers become
available in or around our market areas.





Maintaining Strength in Construction
Lending. Our Real Estate Industries Group (“REIG”) specializes in
residential, commercial and industrial construction loans to experienced,
mid-sized builders in established markets. In Southern California, the primary
non-owner occupied real estate concentration is San Diego County. The majority
of non-owner occupied residential construction consists of projects with one to
five units, followed by condominium construction and tract construction. In
contrast, Northern California efforts have been focused primarily on residential
condominiums in San Francisco and smaller tracts in the East Bay area. The REIG
consists of experienced real estate construction lenders with decades of
successful lending experience. The loan portfolios of this group include
builders that typically have been customers of the loan officers for 6 years or
longer. We believe our loan quality will continue to be enhanced by this degree
of experience at both the loan officer and customer levels, beginning at
underwriting and continuing through loan disbursement, project completion and
the ultimate sale or lease of the completed product.





Building our SBA Loan Origination
Volume. The expansion of the loan volume through our SBA distribution
channel is dependent on hiring seasoned business development officers (“BDOs”)
and increasing the number of loans closed by each BDO. We continually seek to
increase the products available to our BDOs. In January 2007, we reorganized to
focus greater attention in the western states. We strive to capture a greater
portion of the BDOs’ referral sources’ business, thus increasing the loan
production of each BDO. The referral sources are typically commercial real
estate brokers, business brokers, mortgage brokers, attorneys and
accountants.





Response to Market
Decline.  Although some of the real estate markets in which we
lend have experienced significant declines in sales volume and decreased
valuations over the past several months, to date our overall asset quality has
not been dramatically affected due to consistently prudent underwriting
practices and our gradual shift from construction lending to commercial and
industrial and SBA lending.





Maintain Effective Underwriting and
Servicing Standards. We do not compete primarily on the basis of price
for our loan business, but compete based on established relationships with
customers. We also maintain regular review and reporting procedures for all of
our loans in order to judge market and other risks that can affect the types of
loans we fund. This approach allows us to be discerning in evaluating loan
transactions and to competently monitor market risks as a loan is
funded.





Overview of Performance. Our
profitability goals have been realized historically by maintenance of a strong
net interest income as well as expense controls during several consecutive years
of significant internal expansion. This produced earnings for 2007 of $15.1
million, compared to $16.9 million in 2006, and $14.0 million in 2005. Return on
average equity was 14.18% for 2007, compared to 23.89% for 2006, and 27.71% in
2005. Return on average total assets was 1.16% for 2007, compared to 1.64% for
2006, and 1.91% for 2005.





Net interest income before provision
for loan losses has increased to $65.6 million for 2007, compared to $59.8
million for 2006, and $43.5 million in 2005 due to increases in the volume of
interest-earning assets in 2007 and the increases in rates and volume of
interest-earning assets in 2006. Total assets increased 6.49% to $1.32 billion
as of December 31, 2007, compared to $1.24 billion as of December 31, 2006, and
$869.0 million as of December 31, 2005. Average interest-earning assets
increased 30.36% to $1.22 billion for 2007, compared to $939.2 million for 2006,
and $642.2 million in 2005. The net interest margin has decreased to 5.36% in
2007 from 6.37% in 2006, and 6.78% in 2005.





Non-interest income was $16.4 million
as of December 31, 2007, compared to $19.4 million for 2006, and $23.8 million
for 2005. This source of income is principally derived from SBA loan sales. The
decrease in non-interest income in 2007 and 2006 is primarily due to the
decrease in servicing income as a result of the decline in value of servicing
rights as further described in Item 7 of this Form 10-K. We currently anticipate
that for 2008, non-interest income will increase due to the expectation of a
more favorable fair value adjustment of the SBA servicing assets as a result of
lower prepayments and stabilization of the discount rate applied to future
servicing cash flows.


5


We
measure operating expenses as a percentage of average assets. As a percentage of
average assets, operating expenses decreased to 3.99% for 2007, compared to
4.56% for 2006, and 5.57% for 2005. Average assets increased from $730.0 million
as of December 31, 2005, to $1.03 billion as of December 31, 2006, and $1.30
billion as of December 31, 2007. The percentage decrease is a result of
increases in the growth in average assets having outpaced growth in operating
expenses in each of the last three years. The decrease in this ratio is a result
of the company’s efforts to improve efficiency by recruiting successful,
experienced bankers with a track record for high levels of
production.





Lending





Loan
Portfolio Composition





Total
loans, including loans held-for-sale, excluding deferred loan fees, and
allowance for loan losses, were $1.24 billion at December 31, 2007, compared to
$1.15 billion at December 31, 2006, and $758.1 million at December 31, 2005.
Contributing to the increase was the purchase of the unguaranteed portion of
7(a) loans in the amount of $77.8 million which was offset by sales of portfolio
first trust deed loans of $70.2 million. Loan growth is expected to remain
strong in 2008 due to the expansion of our branches and growth of the SBA
wholesale lending unit.





Our loan
portfolio composition is primarily construction, commercial, SBA, and real
estate secured loans. SBA 7(a) loans, of which we are an active originator,
comprise approximately 23% of net loans outstanding as of December 31, 2007 and
2006. Typical of community bank loan markets, a significant portion of our
portfolio is real estate secured. Approximately 92% of our loan portfolio at
December 31, 2007 was real estate secured, compared to 94% at December 31, 2006
and 95% at December 31, 2005. Approximately 47%, 50%, and 51% of our lending
portfolio was classified as real estate construction loans as of December 31,
2007, 2006, and 2005, respectively.





In
December 2006, the federal banking agencies issued final guidance to reinforce
sound risk management practices for bank holding companies and banks in
commercial real estate (“CRE”) loans. The guidance establishes CRE concentration
thresholds as criteria for examiners to identify CRE concentration that may
warrant further analysis. The implementation of these guidelines could result in
increased reserves and capital costs for banks with “CRE concentration”. We
believe that our CRE portfolio as of December 31, 2007 does not have the risks
associated with high CRE concentration due to mitigating factors, including low
loan-to-value ratios, adequate debt coverage ratios, and a wide variety of
property types. Under the final guidance, our ratio of commercial real estate
loans, excluding owner-occupied properties, to capital as of December 31,
2007, is approximately 382%. While this exceeds the 300% benchmark set by
the guidance, we believe we have implemented enhanced risk management practices
as recommended by the guidance. These practices include the review and analysis
of detailed monthly construction loan status reports, detailed monthly
geographic concentration reports by product type and county location, detailed
monthly commercial real estate concentration reports, and centralized monitoring
and servicing of our commercial real estate term loans.





The
weighted-average loan-to-value for our commercial real estate loan portfolio,
excluding owner occupied properties, is approximately 63% at December 31, 2007.
The following table summarizes our loan portfolio, (including loans
held-for-sale), excluding deferred loan fees and allowance for loan loss, by
type of loan and their percentage distribution:





December
      31,2007
            
            2006
            
            2005
            
            2004
            
            2003Amount
            Percent
            
            Amount
            Percent
            
            Amount
            Percent
            
            Amount
            Percent
            
            Amount
            PercentLoan
      portfolio composition:
            (dollars
      in thousands)Commercial
            $
            68,761
            6%
            
            $
            59,663
            5%
            
            $
            25,457
            3%
            
            $
            16,322
            3%
            
            $
            23,630
            7%Real
      estate - Construction
            
            587,992
            47%
            
            
            570,204
            50%
            
            
            385,378
            51%
            
            
            203,885
            38%
            
            
            113,847
            31%Real
      estate – Other
            
            292,869
            23%
            
            
            246,096
            21%
            
            
            248,039
            32%
            
            
            196,098
            36%
            
            
            123,948
            34%SBA
            
            286,410
            23%
            
            
            266,581
            23%
            
            
            94,914
            13%
            
            
            114,799
            22%
            
            
            98,428
            27%Consumer
            
            3,632
            1%
            
            
            3,685
            1%
            
            
            4,306
            1%
            
            
            2,796
            1%
            
            
            3,193
            1%Total
      Loans
            $
            1,239,664
            100%
            
            $
            1,146,229
            100%
            
            $
            758,094
            100%
            
            $
            533,900
            100%
            
            $
            363,046
            100%




6


Loan
Maturity





The
following table sets forth the contractual maturities of gross loans at
December 31, 2007.





One
      year
            
            More
      than 1
            
            More
      than 3
            
            More
      than
            
            Totalor
      less
            
            year
      to 3 years
            
            years
      to 5 years
            
            5
      years
            
            loans(dollars
      in thousands)Commercial
            $
            39,444
            
            $
            19,392
            
            $
            7,610
            
            $
            2,315
            
            $
            68,761Real
      estate - Construction
            
            477,067
            
            
            19,041
            
            
            -
            
            
            91,884
            
            
            587,992Real
      estate – Other
            
            115,167
            
            
            30,480
            
            
            3,686
            
            
            143,536
            
            
            292,869SBA
            
            23,993
            
            
            591
            
            
            3,219
            
            
            258,607
            
            
            286,410Consumer
            
            1,555
            
            
            814
            
            
            1,263
            
            
            -
            
            
            3,632Total
      Gross Loans Outstanding
            $
            657,226
            
            $
            70,318
            
            $
            15,778
            
            $
            496,342
            
            $
            1,239,664





The
majority of our loans have floating rates tied to Wall Street Journal prime or
other market rate indicators. The following table sets forth, as of December 31,
2007, the dollar amounts of net loans outstanding with a maturity date of one
year or more, and whether such loans have fixed or adjustable
rates.





Fixed
            
            
            Adjustable
            
            
            Total(dollars
      in thousands)Commercial
            $
            1,530
            
            $
            27,787
            
            $
            29,317Real
      estate - Construction
            
            417
            
            
            110,595
            
            
            111,012Real
      estate – Other
            
            37,509
            
            
            140,193
            
            
            177,702SBA
            
            1,086
            
            
            261,331
            
            
            262,417Consumer
            
            305
            
            
            1,685
            
            
            1,990Total
      Gross Loans Outstanding
            $
            40,847
            
            $
            541,591
            
            $
            582,438





Loan
Origination and Sale





The
following table sets forth categories of loan originations, loan purchases,
categories of loan sales and principal repayments of loans for the periods
indicated:


At
      December 31,2007
            
            2006
            
            2005
            
            2004
            
            2003(dollars
      in thousands)Beginning
      balance
            $
            1,146,229
            
            $
            758,094
            
            $
            533,900
            
            $
            363,046
            
            $
            272,766Loans
      originated (1):Commercial
            
            589,187
            
            
            437,323
            
            
            323,219
            
            
            237,064
            
            
            161,376Real
      estate:SBA
      & Equity
            
            169,705
            
            
            177,379
            
            
            167,402
            
            
            225,373
            
            
            192,549Construction
            
            1,592,706
            
            
            1,239,794
            
            
            897,862
            
            
            574,150
            
            
            367,464Other
            
            -
            
            
            -
            
            
            11,281
            
            
            44,942
            
            
            96,051Consumer
            
            15,360
            
            
            5,382
            
            
            5,200
            
            
            1,869
            
            
            2,422Total
      loans originated
            
            2,366,958
            
            
            1,859,878
            
            
            1,404,964
            
            
            1,083,398
            
            
            819,862Loans
      purchased:SBA
            
            74,526
            
            
            133,336
            
            
            -
            
            
            -
            
            
            -Total
      loans originated and purchased
            
            2,441,484
            
            
            1,993,214
            
            
            1,404,964
            
            
            1,083,398
            
            
            819,862Loans
      soldCommercialReal
      estate:SBA
            
            156,534
            
            
            160,478
            
            
            151,191
            
            
            199,236
            
            
            129,813First trust deed
            
            58,963Construction
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Other
      - Mortgage
            
            -
            
            
            -
            
            
            13,707
            
            
            45,243
            
            
            100,800Total
      loans sold
            
            215,497
            
            
            160,478
            
            
            164,898
            
            
            244,479
            
            
            230,613Less:Principal
      repayments
            
            2,132,552
            
            
            1,444,601
            
            
            1,015,872
            
            
            668,065
            
            
            498,969Total
      loans
            $
            1,239,664
            
            $
            1,146,229
            
            $
            758,094
            
            $
            533,900
            
            $
            363,046Brokered
      Loans Originated (2)Mortgage
            $
            71,066
            
            $
            96,733
            
            $
            63,735
            
            $
            60,604
            
            $
            65,358SBA
            $
            61,187
            
            $
            65,609
            
            $
            52,470
            
            $
            154,515
            
            $
            65,456(1)   
      Loan originations in many cases are not funded
immediately.(2)   
      Brokered refers to loans that were originated by the Bank but funded by
      other financial institutions.




7


Underwriting
Process





Our
lending activities are guided by the basic lending policies established by our
Board of Directors. Each loan must meet minimum underwriting criteria
established in our lending policies and must fit within our strategies for yield
and portfolio enhancement.





For all
newly originated loans, upon receipt of a completed loan application from a
prospective borrower, a credit report is ordered and, if necessary, additional
financial information is requested. An independent appraisal is required on
every property securing a loan in excess of $250 thousand, which is ordered by
our Appraisal Department. In addition, the loan officer conducts a review of
these appraisals for accuracy, reasonableness, and conformance to our lending
policy on all applications. All revisions to the approved appraiser list must be
approved by the Chief Credit Officer or Chief Appraiser.





Depending
on the loan size and type, our loan approval process consists of a chain of
concurrences beginning with the originating loan officer and rising through the
office/division manager, the Chief Credit Officer, the Chief Administrative
Officer, the Real Estate Lending Manager, the President/CEO and the Board of
Directors. The number of concurring signatures obtained is dependent upon the
dollar amount of the transaction and/or the total liability of the borrowing
relationship. All signatures in the chain must be obtained except in the case of
absence from the bank. In all cases, the signature of the highest required loan
authority must be obtained.





All loans
exceeding the limits of the above mentioned individuals will be forwarded to our
Board of Directors Loan Committee for approval after concurrence by the
appropriate chain of authority. The vote of our Directors Loan Committee will be
obtained by the committee chairman telephonically or in person at the monthly
Board of Directors Loan Committee meeting. The approval or declination by each
member will be indicated on the signature page of the loan report.





If the
loan is approved, the loan commitment specifies the terms and conditions of the
proposed loan including the amount, interest rate, amortization term, a brief
description of the required collateral, and the required insurance coverage.
Generally, the borrower must provide proof of fire, flood (if applicable), and
casualty insurance on the property serving as collateral. This insurance must be
maintained during the full term of the loan. Also, generally, title insurance
endorsed to our bank is required on all real estate secured loans.





We
maintain SBA loan production offices in the mid and western United States and an
office in Florida. SBA loan production offices are typically staffed with a
business development officer who prepares the loan applications and compiles the
necessary information regarding the applicant. All SBA loans are approved at our
Temecula office. The other construction lending and mortgage related loan
production offices, all of which are in California, are typically staffed with
business development officers, underwriters, and processors who send these loans
files to our main office where the credit decision is made. Our retail
full-service branches may include non-SBA commercial, mortgage, and construction
loan officers.





SBA
Lending Programs





The SBA
lending programs are designed by the federal government to assist the small
business community in obtaining financing from financial institutions that are
given government guarantees as an incentive to make the loan. Our bank is a
Nationwide SBA "Preferred Lender". As a "Preferred Lender," we can approve a
loan within the authority given us by the SBA without prior approval from the
SBA. "Preferred Lenders" approve, package, fund, and service SBA loans within a
range of authority that is not available to other SBA lenders without the
"Preferred Lender" designation.





Our SBA
loans fall into two categories, loans originated under the SBA's 7(a) Program
("7(a) loans") and loans originated under the SBA's 504 Program ("504 Loans").
For 2007, 7(a) loans have represented approximately 54% of the SBA Loans
originated while 504, piggyback, USDA business, and industry loan programs have
represented the balance.





Under the
SBA's 7(a) Program, loans in excess of $150 thousand up to $2 million are
guaranteed 75% by the SBA. Generally, this guarantee may become invalid only if
the loan does not meet the SBA underwriting, documentation, and servicing
guidelines. Loans under $150 thousand are guaranteed 85% by the
SBA.





SBA 7(a)
loans collateralized by real estate have terms of up to 25 years, while loans
collateralized by equipment and working capital have terms of up to 10 years and
7 years, respectively. A minimum down payment of 10% is required on most 7(a)
loans, but may require a larger down payment when the real estate collateral
consists of a special purpose or


8


single
use property such as a motel, service station, and/or the business is a
start-up.





We
generally sell the guaranteed portion SBA 7(a) loans, which is up to 85% of the
loan. The remaining portion is the unguaranteed portion of the loans, a portion
of which may also be sold with approval from the SBA. Approximately 5% of the
7(a) loans are generally required to stay on the books of our bank.Funding for these loans has
come principally from retail deposit sources. The SBA loans generally have an
interest rate of 1.00% to 2.75% over Wall Street Journal Prime
Rate.





We retain
the servicing on the sold guaranteed portion of 7(a) loans. The strategy of
selling both the guaranteed and unguaranteed portion of the 7(a) loans allows us
to manage our capital levels and to assist us in meeting the local community
loan demand. Upon sale in the secondary market, the purchaser of the guaranteed
portion of 7(a) loans pays a premium to us, which generally is between 4% and 8%
of the guaranteed amount, and in the case of a sale of the unguaranteed portion,
the premium is usually between 1% and 4%. We also receive a servicing fee equal
to 1% to 5% of the guaranteed amount sold in the secondary market. In the event
that a 7(a) loan has missed payments in the first three months and goes into
default within 270 days of its sale, or prepays within 90 days, we might
repurchase the loan and may be required to refund the premium to the purchaser.
Since our bank has been open, we have repurchased 47 loans, however only 3 of
these repurchased loans required a refund of the premium. No refunds were owed
on the other 44loans
repurchased.





Under the
SBA's 504 Program, we require a minimum down payment of 10% (more on special
purpose, single use properties, or start-ups). We then enter into a 50% first
trust deed loan to the borrower and an interim up to 40% second trust deed loan.
The first trust deed loan must be equal to half of the original maturity of the
related debenture. The second trust deed loan is usually for a term of 120 days.
Within the 120 day period of entering into the loan, the second trust deed loans
are refinanced by SBA certified development companies and used as collateral for
SBA guaranteed debentures. For 504 construction loans, the term on the second
trust deed loan is generally 18 months and the Certified Development Company
cannot payoff the loan until a notice of completion is filed. The first trust
deed loan on a construction project is generally a term of 25 years and 18
months. Before releasing the funds to the borrower, the first trust deed loans
may be pre-sold with no recourse. We retain no servicing on 504 Loans after they
are sold.





Our SBA
lending program, and portions of our real estate lending, are dependent on the
continual funding and programs of certain federal agencies or quasi-government
corporations, including the SBA. The guaranteed portion of an SBA loan does not
count towards our bank’s loans-to-one-borrower limitation which, at December 31,
2007 was $38.8 million.





SBA
lending is a federal government created and administered program. As such,
legislative and regulatory developments can affect the availability and funding
of the program. This dependence on legislative funding and regulatory
restrictions from time to time causes limitations and uncertainties with regard
to the continued funding of such loans, with a resulting potential adverse
financial impact on our business. Currently, the maximum limit of individual
7(a) loans which the SBA will permit is $2 million. Any reduction in the maximum
loan amount or the maximum guaranty amount could have a negative impact on our
business. Since the SBA lending of our bank constitutes a significant portion of
our lending business, dependence on this government program, and its periodic
uncertainty with availability and amounts of funding, creates greater risk for
our business than do other parts of our business.





Commercial
Lending/Real Estate Lending





Generally,
our commercial loans are underwritten in our market area on the basis of the
borrower's ability to service such debt from identified cash flow. We usually
take as collateral a lien on available real estate, equipment or other assets
and obtain a personal guaranty of the business principals.





In
addition to commercial loans secured by real estate, we make commercial mortgage
loans to finance the purchase of real property, which generally consists of real
estate on which structures have already been completed or will be completed and
occupied by the borrower. We offer a variety of mortgage loan products that
generally are amortized over 10 to 25 years. Our commercial mortgage loans are
secured by first liens on real estate. Typically, we have both fixed and
variable interest rates and amortize over a 10 to 25 year period with balloon
payments due at the end of 3 to 10 years. As a Preferred SBA Lender (discussed
above), we also issue full term variable rate real estate loan commitments when
the facility is enhanced by the underlying SBA guaranty. In underwriting
commercial mortgage loans, consideration is given to the property's operating
history, future operating


9


projections,
current and projected occupancy, location and physical condition. The
underwriting analysis also includes credit checks, appraisals, environmental
assessments and a review of the financial condition of the
borrower.





Construction
Lending





We
originate construction loans on both one-to-four-family residences and on
commercial real estate properties. We originate owner-occupied construction
loans to build single family residences. We also originate construction loans to
companies engaged in the business of constructing homes for re-sale. These loans
may be for homes currently under contract for sale or homes built for sale
purposes to be marketed for sale during construction. For owner-occupied single
family residences, the borrower and the property must qualify for permanent
financing. Prequalification for owner-occupied single family residences is
required. For commercial property, the borrower must qualify for permanent
financing and the debt service coverage must be 1.20 to 1 or more (except for
SBA loans). Qualification for permanent financing should be determined by the
loan officer as part of the credit presentation. Absent such prequalification,
we will not approve a construction loan. We originate land acquisition and
development loans with the source of repayment being either the sale of finished
lots or the sale of homes to be constructed on the finished lots. Construction
loans are generally offered with terms up to 24 months.





Construction
loans are generally made in amounts up to 75% of the value of the security
property for non-owner single family residences and commercial properties and up
to 75% for owner-occupied single family residences. During construction, loan
proceeds are disbursed in draws as construction progresses based upon
inspections of work in place by independent construction inspectors. At December
31, 2007, construction loans, including land acquisition and development loans
totaled $588.0 million or approximately 47% of our total loan
portfolio.





Construction
loans are generally considered to involve a higher degree of credit risk than
long-term financing on improved, owner-occupied real estate. Risk of loss on a
construction loan is dependent largely upon the accuracy of the initial estimate
of the security property's value upon completion of construction as compared to
the estimated costs of construction, including interest. Also, we assume certain
risks associated with the borrower's ability to complete construction in a
timely and workmanlike manner. If the estimate of value proves to be inaccurate,
or if construction is not performed timely or accurately, we may be confronted
with a project which, when completed, has a value which is insufficient to
assure full repayment.





Consumer
Lending





Consumer
loans include automobile loans, recreational vehicle loans, boat loans, home
improvement loans, home equity lines of credit, personal loans (collateralized
and uncollateralized), and deposit account collateralized loans. The terms of
these loans typically range from 12 to 120 months and vary based upon the nature
of collateral and size of loan. Our portfolio of consumer loans primarily
consists of installment loans secured by new or used automobiles, boats and
recreational vehicles, and loans secured by deposits. At December 31, 2007,
consumer loans totaled $3.6 million.





As of
December 31, 2007, home equity lines totaled $3.7 million, or 0.3% our gross
loan portfolio. Our home equity lines are adjustable-rate and reprice with
changes in our internal prime rate. Adjustable-rate home equity lines of credit
are offered in amounts up to 80% of the appraised value. Home equity lines of
credit are offered with terms up to 10 years.





Loan
Servicing





The loan
participations we sell are serviced by our loan servicing department. The loan
officer is responsible for the day-to-day relationship with the customer, unless
the loan becomes delinquent (60 days or more past due), at which time the
responsibilities are reassigned to credit administration. Loan servicing is
centralized at our corporate headquarters. As of December 31, 2007, we were
servicing $447.3 million of loans originated that were sold to other
investors.





Our loan
servicing operations, performed by the loan servicing department, are intended
to provide prompt customer service and accurate and timely information for
account follow-up, financial reporting and management review. Following the
funding of an approved loan, all pertinent loan data is entered into our data
processing system, which provides monthly billing statements, tracks payment
performance, and effects agreed upon interest rate adjustments on loans. Regular
loan service efforts include payment processing and collection notices, as well
as tracking the performance of additional borrower obligations with respect to
the maintenance of casualty insurance coverage, payment of property taxes


10


and
senior liens. When payments are not received by their contractual due date,
collection efforts begin on the 11th day of
delinquency with a telephone contact. If the borrower is non-responsive or the
loan officer feels more stringent action may be required, the Chief Credit
Officer is consulted. Notices of default are generally filed when the loan has
become 30-90 days past due.





Credit
Risk and Loan Review





We incur
credit risk whenever we extend credit to, or enter into other transactions with,
our customers. The risks associated with extensions of credit include general
risk, which is inherent in the lending business, and risk specific to individual
borrowers. Loan review and other loan monitoring practices provide a means for
our management to ascertain whether proper credit, underwriting and loan
documentation policies, procedures and practices are being followed by our loan
officers and are being applied uniformly throughout our bank. The Chief Risk
Officer oversees the daily administration of loan review. The Chief Credit
Officer and Assistant Chief Credit Officer approve loan officer requests for
changes in risk ratings. Loan officers are responsible for continually grading
their loans so that individual credits properly reflect the risk inherent
therein. On an annual or semi-annual basis, our Board of Directors provides for
a third-party outside loan review of all loans that meet certain criteria
originated since the previous review. While we continue to review these and
other related functional areas, there can be no assurance that the steps we have
taken to date will be sufficient to enable us to identify, measure, monitor and
control all credit risk.





Concentrations
of Credit





Our
primary investment is in loans, 92%of which were secured by
real estate as of December 31, 2007. Therefore, although we monitor the real
estate loan portfolio on a regular basis to avoid undue concentrations to a
single borrower or type of real estate collateral, real estate in general is
considered a concentrated investment. We seek to mitigate this risk by requiring
each borrower to have a certain amount of equity in the real estate at the time
of origination, depending on the type of real estate and the credit quality of
the borrower. Trends in the market are monitored closely by management on a
regular basis.





Under
state law, our ability to make aggregate secured loans-to-one-borrower is
limited to 25% of unimpaired capital and surplus (as of December 31, 2007, this
amount was $38.8 million).





Investment
Activities





Our investment policy, as established
by our Board of Directors, attempts to provide for and maintain liquidity,
generate a favorable return on investments without incurring undue interest rate
and credit risk, and complement our lending activities. Our company's policies
provide the authority to invest in bank-qualified securities and any investment
purchases outside our policy guidelines must be approved by our Board of
Directors or committee thereof. Purchases and sales under this limitation and
within the guidelines of our policies may be completed at the discretion of our
President, Chief Financial Officer or Chief Operating Officer. At
December 31, 2007, we held $3.0 million in FNMA Mortgage-backed securities,
$2.9 million in Federal Home Loan Bank (“FHLB”) stock, and $4.2 million in
federal funds sold.





Nonaccrual,
Past Due and Restructured Loans





Nonperforming assets consist of
nonperforming loans and Other Real Estate Owned (“OREO”). We had $30.9 million
of nonperforming loans as of December 31 2007, of which $10.4 million was
guaranteed by the SBA, compared to $19.1 million of nonperforming loans as of
December 31 2006, of which $10.3 million was guaranteed by the SBA, and $8.0
million of nonperforming loans as of December 31, 2005, of which $6.5 million
was government guaranteed. We had no OREO at December 31, 2007. We had $1.3
million at December 31, 2006, of which $638 thousand was guaranteed by the SBA,
and $2.1 million at December 31, 2005, of which $604 thousand was guaranteed by
the SBA.





Pursuant to SBA operating procedures,
real estate collateral is liquidated when a loan becomes uncollectible. Should
there be a shortfall in liquidation proceeds of an SBA guaranteed loan; the SBA
will assume 75% - 85% of that shortfall. The ratio of nonperforming SBA loans to
total loans (after reducing for SBA guarantees) was 1.66%, 0.77%, and 0.19% for
the years ended December 31, 2007, 2006, and 2005, respectively.





We generally place a loan on nonaccrual
status and cease accruing interest when loan payment performance is deemed
unsatisfactory. All loans past due 90 days are placed on nonaccrual status,
unless the loan is both well secured and in the process of collection. Cash
payments received, while a loan is classified as nonaccrual, are recorded as a
deduction of principal as long as doubt exists as to collection. We are
sometimes required to revise a loan's interest rate or repayment terms in a
troubled debt restructuring. Restructured loans totaled


11


$539
thousand at December 31, 2007. We had no restructured loans as of
December 31, 2006 or 2005. Our credit administration department regularly
evaluates potential problem loans as to risk exposure to determine the adequacy
of our allowance for loan losses.





We review collateral value on loans
secured by real estate during the internal loan review process. New appraisals
are acquired when loans are categorized as renewed, nonperforming or potential
problem loans. In instances where updated appraisals reflect reduced collateral
values, an evaluation of the borrower's overall financial condition is made to
determine the need, if any, for possible write-downs or appropriate additions to
our allowance for loan losses.





The following table presents
information concerning nonaccrual loans, OREO, accruing loans which are
contractually past due 90 days or more, as to interest or principal
payments and still accruing, and restructured loans:





Nonaccrual,
      Past Due, and Restructured LoansDecember
      31, 2007
            
            December
      31, 2006Gross
            
            Government
            
            Net
            
            Gross
            
            Government
            
            NetBalance
            
            Guaranteed
            
            Balance
            
            Balance
            
            Guaranteed
            
            BalanceNonaccrual
      loans (Gross):
            (dollars
      in thousands)Commercial
            $
            371
            
            $
            -
            
            $
            371
            
            $
            89
            
            $
            (44)
            
            $
            45Real
      Estate - Construction
            
            11,242
            
            
            (288)
            
            
            10,954
            
            
            5,942
            
            
            -
            
            
            5,942Real
      Estate - Other
            
            19,323
            
            
            (10,091)
            
            
            9,232
            
            
            13,093
            
            
            (10,290)
            
            
            2,803Installment
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Total
            
            30,936
            
            
            (10,379)
            
            
            20,557
            
            
            19,124
            
            
            (10,334)
            
            
            8,790OREO
            
            -
            
            
            -
            
            
            -
            
            
            1,255
            
            
            (638)
            
            
            617Total
      nonaccrual loans and OREO
            $
            30,936
            
            $
            (10,379)
            
            $
            20,557
            
            $
            20,379
            
            $
            (10,972)
            
            $
            9,407Gross
      nonaccrual loans as a percentage of total loans
            
            
            
            2.50%
            
            
            
            
            
            
            
            
            1.67%Gross
      nonaccrual loans and OREO as a percentage of total loans and
      OREO
            
            2.50%
            
            
            
            
            
            
            
            
            1.78%Allowance
      for loan losses to total net loans (including
    held-for-sale)
            
            
            1.29%
            
            
            
            
            
            
            
            
            1.10%Allowance
      for loan losses to total net loans (excluding
    held-for-sale)
            
            
            1.56%
            
            
            
            
            
            
            
            
            1.29%Allowance
      for loan losses to gross nonaccrual loans
            
            
            
            
            
            51.79%
            
            
            
            
            
            
            
            
            65.48%Loans
      past due 90 days or more on accrual status:Commercial
            
            
            
            
            
            
            $
            -
            
            
            
            
            
            
            
            $
            26Real
      Estate
            
            
            
            
            
            
            
            -
            
            
            
            
            
            
            
            
            114Installment
            
            
            
            
            
            
            
            -
            
            
            
            
            
            
            
            
            -Total
            
            
            
            
            
            
            $
            -
            
            
            
            
            
            
            
            $
            140Restructured
      loans:On
      accrual status
            
            
            
            
            
            
            $
            -
            
            
            
            
            
            
            
            $
            -On
      nonaccrual status
            
            
            
            
            
            
            
            539
            
            
            
            
            
            
            
            
            -Total
            
            
            
            
            
            
            $
            539
            
            
            
            
            
            
            
            $
            -





The table below summarizes the
approximate changes in gross nonaccrual loans for the years ended
December 31, 2007, 2006, and 2005.


2007
            
            2006
            
            2005(dollars
      in thousands)Balance,
      beginning of the year
            $
            19,124
            $
            7,951
            $
            11,799Loans
      placed on nonaccrual
            
            25,048
            
            15,265
            
            3,840Charge-offs
            
            (1,336)
            
            (381)
            
            (540)Loans
      returned to accrual status
            
            (14,771)
            
            (3,936)
            
            (6,586)Repayments
      (including interest applied to principal)
            
            1,460
            
            2,356
            
            1,920Transfers
      to OREO
            
            1,411
            
            (2,131)
            
            (2,482)Balance,
      end of year
            $
            30,936
            $
            19,124
            $
            7,951





The additional interest income that
would have been recorded from nonaccrual loans if the loans had not been placed
on nonaccrual status was $4.1 million, $2.0 million, and $898 thousand for the
years ended December 31, 2007, 2006, and 2005, respectively.





Interest
payments received on nonaccrual loans are applied to principal, unless there is
no doubt as to ultimate full repayment of principal, in which case, the interest
payment is recognized as interest income. Interest income not recognized on
nonaccrual loans reduced the net interest margin by 34 basis points, 22 basis
points, and 14 basis points for the years ended December 31, 2007, 2006,
and 2005, respectively.


12


Other
Real Estate Owned (“OREO”)





We had no OREO at December 31, 2007.
OREO was $1.3 million at December 31, 2006, of which $638 thousand was
guaranteed by the SBA, compared to $2.1 million at December 31, 2005, of which
$604 thousand was guaranteed by the SBA. Our policy is to record these
properties at the lower of cost or estimated fair value, net of selling
expenses, at the time they are transferred into OREO, thereby tying future gains
or losses from sale or potential additional write-downs to underlying changes in
the market.





Potential
Problem Loans





In addition to loans disclosed above as
past due, nonaccrual and restructured as of December 31, 2007, management also
identified further weaknesses in $6.3 million of already classified loans.
Estimated potential losses from these potential credit weaknesses have been
provided for in determining the allowance for loan losses at December 31,
2007.





Our management's classification of
credits as nonaccrual, restructured or problems does not necessarily indicate
that the principal is uncollectible in whole or part.





Allowance
for Loan Losses





The allowance for loan losses is a
valuation allowance for probable incurred credit losses which is established
through charges to earnings in the form of a provision for loan losses. Based on
an evaluation of our loan portfolio, management presents a quarterly review of
the allowance for loan losses to our Board of Directors, indicating any change
in the allowance since the last review and any recommendations as to
adjustments. In making our evaluation, we consider the diversification by
industry of our commercial loan portfolio, the effect of changes in the local
real estate market on collateral values, the results of recent regulatory
examinations, the effects on the loan portfolio of current economic indicators
and their probable impact on borrowers, the amount of charge-offs for the
period, the amount of nonperforming loans and related collateral security, and
the evaluation of our loan portfolio through our loan review function. A
charge-off occurs when a loan is deemed to be uncollectible. We establish
specific allowances for loans which management believes require reserves greater
than those allocated according to their classification or delinquent status as
prescribed in Statement of Financial Accounting Standards (“SFAS”) No. 114,
“Accounting by Creditors for
Impairment of a Loan”, as amended by SFAS No. 118, “Accounting by Creditors for
Impairment of a Loan – Income Recognition and Disclosures”.The amount of
the specific allocation is based on the estimated value of the collateral
securing the loans and other analyses pertinent to each situation. Loans are
identified for specific allowances from information provided by several sources
including asset classification, third party reviews, delinquency reports,
periodic updates to financial statements, public records, and industry reports.
All loan types are subject to specific allowances once identified as impaired or
nonperforming.





Additionally, we use two approaches for
the analysis of the performing portfolio: general factors and historical losses.
These methods are further broken down into identified loan pools within our
portfolio. Using these methodologies, we provide loss allocations to each
identified loan classification and to performing loan pools. All pools are
evaluated by both methods. We then charge to operations a provision for loan
loss to maintain the allowance for loan losses at the level determined by the
foregoing methodology.





We follow a loan review program to
evaluate credit risk in our loan portfolio. Through the loan review process, we
maintain an internally classified loan watch list, which, along with the
delinquency list of loans, helps us assess the overall quality of the loan
portfolio and our allowance for loan losses. Loans classified as "substandard"
are those loans with clear and defined weaknesses such as a highly leveraged
position, unfavorable financial ratios, uncertain repayment sources or poor
financial condition, which may jeopardize ultimate recoverability of the
debt.





Loans classified as "doubtful" are
those loans that have characteristics similar to substandard loans but with an
increased risk that a loss may occur, or at least a portion of the loan may
require a charge-off if liquidated at present. Although loans classified as
substandard do not duplicate loans classified as doubtful, both substandard and
doubtful loans include some loans that are delinquent at least 30 days or on
nonaccrual status.





In addition to loans on the internal
watch list classified as substandard or doubtful, we maintain additional
classifications on a separate watch list which further aids us in monitoring
loan portfolios. These additional loan classifications reflect warning elements
where the present status portrays one or more deficiencies that require
attention in the short-


13


term or
where pertinent ratios of the loan account have weakened to a point where more
frequent monitoring is warranted. These loans do not have all of the
characteristics of a classified loan (substandard, doubtful) but do show
weakened elements as compared with those of a satisfactory credit. We regularly
review these loans to aid in assessing our allowance for loan
losses.





The economy of our market areas remains
dependent on real estate and related industries (i.e. construction, housing). We
maintain a reasonably diverse commercial and consumer loan portfolio. Downturn
in real estate or construction has had an adverse effect on borrowers' ability
to repay loans and has affected our results of operations and financial
condition and these changes are taken into account when we evaluate our
allowance. Additionally, we have several procedures in place to assist us in
minimizing credit risk and maintaining the overall quality of our loan
portfolio. We frequently review and update our underwriting guidelines and
monitor our delinquency levels for any negative or adverse trends.





The
provision for loan loss is the amount expensed and added to the allowance for
loan losses. The allowance is kept at a level that is determined by a quarterly
analysis of the loan portfolio and represents the probable incurred credit
losses in the portfolio. The following table summarizes the activity in the
allowance for loan losses for the five years ended December 31,
2007:





Allowance
      for Loan LossesYear
      ended December 31,2007
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003(Dollars
      in Thousands)Loans
      outstanding and loans held-for-sale
            $
            1,237,717
            
            $
            1,142,693
            
            $
            753,246
            
            $
            530,196
            
            $
            360,749Average
      amount of loans outstanding
            
            1,196,849
            
            
            922,264
            
            
            634,731
            
            
            446,493
            
            
            318,600Balance
      of allowance for loan losses,
              beginning
      of years
            
            12,522
            
            
            9,039
            
            
            6,362
            
            
            3,608
            
            
            3,017Loans
      charged off:Commercial
            
            (449)
            
            
            (208)
            
            
            (250)
            
            
            (986)
            
            
            (464)Real
      Estate - Construction
            
            (100)
            
            
            (10)
            
            
            -
            
            
            -
            
            
            -Real
      Estate - Other
            
            (787)
            
            
            (159)
            
            
            (286)
            
            
            (105)
            
            
            (37)Consumer
            
            -
            
            
            (4)
            
            
            (4)
            
            
            (6)
            
            
            (4)Total
      loans charged off
            $
            (1,336)
            
            $
            (381)
            
            $
            (540)
            
            $
            (1,097)
            
            $
            (505)Recoveries
      of loans previously charged off:Commercial
            
            148
            
            
            202
            
            
            281
            
            
            23
            
            
            19Real
      Estate – Construction
            
            -
            
            
            10
            
            
            -
            
            
            -
            
            
            -Real
      Estate - Other
            
            88
            
            
            1
            
            
            39
            
            
            3
            
            
            33Consumer
            
            -
            
            
            1
            
            
            -
            
            
            4
            
            
            22Total
      recoveries of loans
            $
            236
            
            $
            214
            
            $
            320
            
            $
            30
            
            $
            74Net
      loans charged off
            
            (1,100)
            
            
            (167)
            
            
            (220)
            
            
            (1,067)
            
            
            (431)Provision
      for Loan loss expense
            
            4,600
            
            
            3,650
            
            
            2,897
            
            
            3,821
            
            
            1,022Balance,
      end of year
            $
            16,022
            
            $
            12,522
            
            $
            9,039
            
            $
            6,362
            
            $
            3,608





The
following table describes the allocation of the allowance for loan losses among
various categories of loans and certain other information for the dates
indicated. The allocation is made for analytical purposes and is not necessarily
indicative of the categories in which future losses may occur. The total
allowance is available to absorb losses from any segment of
loans.


14





At
      the Years Ended December 31,2007
            
            
            
            
            
            
            2006Allowance
      Amount
            
            % of
      Allowance to Total Amount
            
            % in
      Loans in Each Category to Total Loans
            
            
            Allowance
      Amount
            
            % of
      Allowance to Total Amount
            
            % in
      Loans in Each Category to Total Loans(dollars
      in thousands)Commercial
            $
            719
            
            4.5%
            
            5.6%
            
            $
            658
            
            5.3%
            
            5.2%Real
      Estate
            
            2,458
            
            15.3%
            
            23.6%
            
            
            2,159
            
            17.2%
            
            25.7%Construction/Land
      Development
            
            7,727
            
            48.2%
            
            47.5%
            
            
            5,658
            
            45.2%
            
            49.8%SBA
            
            5,079
            
            31.7%
            
            23.1%
            
            
            4,008
            
            32.0%
            
            19.1%Consumer
      & Other
            
            39
            
            0.3%
            
            0.2%
            
            
            39
            
            0.3%
            
            0.2%Total
            $
            16,022
            
            100.0%
            
            100.0%
            
            $
            12,522
            
            100.0%
            
            100.0%At
      the Years Ended December 31,2005
            
            
            
            
            
            
            2004Allowance
      Amount
            
            % of
      Allowance to Total Amount
            
            % in
      Loans in Each Category to Total Loans
            
            
            Allowance
      Amount
            
            % of
      Allowance to Total Amount
            
            % in
      Loans in Each Category to Total Loans(dollars
      in thousands)Commercial
            $
            254
            
            2.8%
            
            3.4%
            
            $
            178
            
            2.8%
            
            3.1%Real
      Estate
            
            2,027
            
            22.4%
            
            32.7%
            
            
            1,590
            
            25.0%
            
            36.4%Construction/Land
      Development
            
            4,253
            
            47.1%
            
            50.7%
            
            
            1,958
            
            30.7%
            
            38.0%Mortgage
            
            -
            
            0.0%
            
            0.0%
            
            
            -
            
            0.0%
            
            0.4%SBA
            
            2,462
            
            27.2%
            
            12.6%
            
            
            2,612
            
            41.1%
            
            21.6%Consumer
      & Other
            
            43
            
            0.5%
            
            0.6%
            
            
            24
            
            0.4%
            
            0.5%Total
            $
            9,039
            
            100.0%
            
            100.0%
            
            $
            6,362
            
            100.0%
            
            100.0%At
      the Year Ended December 31,2003Allowance
      Amount
            
            % of
      Allowance to Total Amount
            
            % in
      Loans in Each Category to Total Loans(dollars
      in thousands)Commercial
            $
            154
            
            4.3%
            
            6.5%Real
      Estate
            
            655
            
            18.2%
            
            33.4%Construction/Land
      Development
            
            589
            
            16.3%
            
            31.2%Mortgage
            
            -
            
            0.0%
            
            0.7%SBA
            
            2,184
            
            60.5%
            
            27.3%Consumer
      & Other
            
            26
            
            0.7%
            
            0.9%Total
            $
            3,608
            
            100.0%
            
            100.0%





The allowance for loan losses as a
percentage of net loans outstanding and loans held-for-sale was 1.29% as of
December 31, 2007, 1.10% as of December 31, 2006, and 1.20% as of December 31,
2005. The allowance for loan losses as a percentage of net loans outstanding,
excluding loans held-for-sale, was 1.56% as of December 31, 2007, 1.29% as of
December 31 2006, and 1.35% as of December 31, 2005.





As a
result of decreases in local and regional real estate values and the significant
losses experienced by many financial institutions, there has been greater
regulatory scrutiny of the loan portfolios. While we believe we have established
our existing allowance for loan losses in accordance with U.S. generally
accepted accounting principles, there can be no assurance that regulators, in
reviewing our loan portfolio, will not request that we increase significantly
our allowance for loan losses. In addition, because future events affecting
borrowers and collateral cannot be predicted with certainty, there can be no
assurance that the existing allowance for loan losses is adequate or that
substantial increases will not be necessary should the quality of any loans
deteriorate as a result of the factors discussed above. Any material increase in
the allowance for loan losses may adversely affect our financial condition and
results of operations.


15


Deposits




We offer a variety of deposit accounts,
having a wide range of interest rates and terms, consisting of demand, savings,
money market, and time accounts. We rely primarily on competitive pricing
policies, customer service, and referrals to attract and retain these deposits.
The daily average balances and weighted average rates paid on deposits and
other  borrowings for each of the years ended December 31, 2007,
2006, and 2005 are represented below.





Years
      Ended December 31,2007
            
            
            
            
            
            
            2006Average
      Balance
            
            % of
      total Average Deposits / Borrowings
            
            Average
      Rate %
            
            
            Average
      Balance
            
            % of
      total Average Deposits / Borrowings
            
            Average
      Rate %(Dollars
      in Thousands)NOW
            $
            31,543
            
            2.7%
            
            0.15%
            
            $
            31,161
            
            3.3%
            
            0.15%Money
      Market
            
            119,922
            
            10.2%
            
            3.71%
            
            
            83,672
            
            8.8%
            
            3.26%Savings
            
            29,460
            
            2.5%
            
            0.43%
            
            
            31,685
            
            3.3%
            
            0.39%Time
      deposits less than $100,000
            
            404,244
            
            34.3%
            
            5.09%
            
            
            293,909
            
            31.0%
            
            4.72%Time
      deposits $100,000 and over
            
            410,680
            
            34.8%
            
            5.31%
            
            
            315,346
            
            33.3%
            
            4.74%Other
      Borrowings
            
            39,560
            
            3.4%
            
            7.56%
            
            
            36,906
            
            3.9%
            
            7.41%Total
      interest-bearing liabilities
            
            1,035,409
            
            87.9%
            
            4.83%
            
            
            792,679
            
            83.6%
            
            4.35%Non
      interest-bearing deposits
            
            144,317
            
            12.1%
            
            0.00%
            
            
            154,473
            
            16.4%
            
            0.00%Total
      Deposits & Other Borrowings
            $
            1,179,726
            
            100.0%
            
            3.64%
            
            $
            947,152
            
            100.0%
            
            3.64%Year
      Ended December 31,2005Average
      Balance
            
            % of
      total Average Deposits / Borrowings
            
            Average
      Rate %(Dollars
      in Thousands)NOW
            $
            32,791
            
            4.9%
            
            0.15%Money
      Market
            
            50,239
            
            7.5%
            
            1.81%Savings
            
            38,010
            
            5.7%
            
            0.37%Time
      deposits less than $100,000
            
            175,124
            
            26.1%
            
            3.17%Time
      deposits $100,000 and over
            
            194,496
            
            29.0%
            
            3.24%Other
      Borrowings
            
            28,993
            
            4.3%
            
            5.64%Total
      interest-bearing liabilities
            
            519,653
            
            77.5%
            
            2.81%Non
      interest-bearing deposits
            
            151,447
            
            22.5%
            
            0.00%Total
      Deposits & Other Borrowings
            $
            671,100
            
            100.0%
            
            2.17%





At
December 31, 2007, we had $399.6 million in time deposits in the amounts of
$100,000 or more, consisting of 2,346 accounts, maturing as
follows:





Maturity
      Period
            
            Amount
            Weighted
      Average Rate(dollars
      in thousands)Three
      months or less
            $
            187,872
            5.10%Greater
      than Three Months to Six Months
            
            138,301
            4.96%Greater
      than Six Months to Twelve Months
            
            71,114
            4.89%Greater
      than Twelve Months
            
            2,316
            4.74%Total
            $
            399,603
            5.01%




16


Short-term
Borrowings




The table below is a schedule of
outstanding short-term borrowings (less than or equal to 1
year):




Year
      Ended December 31,2007
            
            
            2006
            
            
            2005(dollars
      in thousands)FHLB
      advances
            $
            -
            
            $
            -
            
            $
            30,000Total
      Short-term Borrowings
            $
            -
            
            $
            -
            
            $
            30,000





Recently
Issued Accounting Standards





See
“Adoption of New Accounting Standards” and “Effect of Newly Issued but Not Yet
Effective Accounting Standards” in Note A of our Consolidated Financial
Statements included in this Annual Report.





Competition





We
compete with many other entities with respect to originating loans, generating
deposits and providing other banking services. Major banks dominate the market
with multiple offices and a panoply of products and services, with very few
geographic barriers. Major advertising campaigns and the ability to invest in
regions of higher yield and demand often provide larger institutions a
competitive edge. In addition, they are able to offer certain services which we
do not offer directly and, by virtue of their greater total capitalization, have
substantially higher lending limits than we offer. Other entities, both public
and private, seeking to raise capital through the issuance and sale of debt or
equity securities also compete with us for the acquisition of deposits. In
recent years, increased competition has also developed from specialized finance
and non-finance companies that offer wholesale finance, credit card and other
consumer finance services (including online banking services and personal
financial software). Competition for deposit and loan products remains strong
from both banking and non-banking institutions and this competition directly
affects the rates of products and the terms on which products are offered to
consumers and businesses.





Technological
innovation contributes to greater domestic and international competition by both
depository and non-depository institutions. Moreover, mergers place additional
pressure on banks within the industry to consolidate their operations, reduce
expenses and increase revenues, and federal and state interstate banking laws
which allow banks to merge with other banks across state lines enable banks to
establish or expand banking operations in our most significant markets. The
competitive environmental is also significantly affected by federal and state
legislation which often makes it easier for non-bank financial institutions to
compete with us.





Economic
factors, along with legislative and technological changes, will have an ongoing
impact on the competitive environment in which we operate. We attempt to
anticipate and adapt to competitive conditions, but we can make no assurance as
to the effectiveness of these efforts on our future business or results of
operations or as to our continued ability to anticipate and adapt to changing
conditions. In order to compete, we emphasize personal banking relationships and
place an emphasis on continual expansion of the services and products we offer.
We believe that through these efforts, we can be competitive with and
distinguish ourselves from other community banks and financial services
providers in our marketplace. However, we can provide no assurance that we will
be able to sufficiently improve our services and/or banking products or
successfully compete in our primary service areas.





Supervision and
Regulation





Bank holding companies and banks are
extensively regulated under state and federal law. These laws are generally
intended to protect depositors and customers, not shareholders. The following is
a brief summary of certain statutes and rules that affect or will affect our
company and our bank. This summary is qualified in its entirety by reference to
the particular statute and regulatory provisions referred to below and is not
intended to be an exhaustive description of all applicable statutes and
regulations. Any change in applicable laws or regulations may have a material
adverse effect in our business and prospects. Our operations may be affected by
legislature changes and by the policies of various regulatory authorities. We
cannot accurately predict the nature or the extent of the effects on our
business and earnings that fiscal or monetary policies, or new federal or state
legislation may have in the future. Our company is subject to the disclosure and
regulatory requirements of the Securities Act of 1933, as amended, and the
Securities Exchange Act of 1934, as amended, both as administered by the
Securities and Exchange Commission (“SEC”). As a listed company on NASDAQ, our
holding company is subject to NASDAQ rules for listed companies.


17


Holding Company Regulation.As a bank holding company, our company principally is subject to Federal
Reserve regulations. We are required to file with the Federal Reserve quarterly
and annual reports and such additional information the Federal Reserve may
require pursuant to the BHCA. The Federal Reserve may conduct examinations of
bank holding companies and their subsidiaries.





Under a policy of the Federal Reserve,
with respect to bank holding company operations, a bank holding company is
required to serve as a source of financial strength to its subsidiary depository
institutions and to commit resources to support such institutions in
circumstances where it might not do so absent such a policy. The Federal
Reserve, under the BHCA, also has the authority to require a bank holding
company to terminate any activity or to relinquish control of a nonbank
subsidiary (other than a nonbank subsidiary of a bank) upon the Federal
Reserve's determination that such activity or control constitutes a serious risk
to the financial soundness and stability of any bank subsidiary of the bank
holding company. The Federal Reserve may also prohibit our company, except in
certain instances prescribed by statute, from acquiring or engaging in
nonbanking activities, other than activities that are deemed by the Federal
Reserve to be so closely related to banking or managing or controlling banks as
to be a proper incident thereto. See "Recent and Proposed Legislation" in this
Section.





Federal and State Bank
Regulation. As a California state-chartered bank, our bank is subject to
supervision, periodic examination and regulation by the California Department of
Financial Institutions (“DFI”) and the FDIC. If the regulators should determine
that the financial condition, capital resources, asset quality, earnings
prospects, management, liquidity or other aspects of our bank's operations are
unsatisfactory or that our bank or our management is violating or has violated
any law or regulation, various remedies are available to and are utilized by the
regulators. Such remedies include the power to enjoin unsafe or unsound
practices, to require affirmative action to correct any conditions resulting
from any violation or practice, to issue an administrative order that can be
judicially enforced, to direct an increase in capital, to restrict growth, to
assess civil monetary penalties, to remove officers and directors and ultimately
to request the FDIC to terminate our bank's deposit insurance. Our bank has
never been subject to any such enforcement action.





Because
Californiapermits
commercial banks chartered by the state to engage in any activity permissible
for national banks, our bank can form subsidiaries to engage in activates
“closely related to banking” or “nonbanking” activities and expanded financial
activities. However, to form a financial subsidiary, our bank must be well
capitalized and would be subject to the same capital deduction, risk management
and affiliate transaction rules as applicable to national banks. Generally, a
financial subsidiary is permitted to engage in activities that are “financial in
nature” or incidental thereto, even though they are not permissible for the
national bank to conduct directly within the bank. The definition of “financial
in nature” includes, among other items, underwriting, dealing in or making a
market in securities, including, for example, distributing shares of mutual
funds. The subsidiary may not, however, engage as principal in underwriting
insurance (other than credit life insurance), issue annuities or engage in real
estate development or investment or merchant banking. Presently, our bank does
not have any subsidiaries.





Statutes
and regulations relate to virtually every aspect of our bank's operations,
including reserves against deposits, ownership of deposit accounts, interest
rates payable on deposits, loans, investments, mergers and acquisitions,
borrowings, dividends, locations of branch offices and capital requirements.
Further, our bank is required to maintain certain levels of
capital.  See "Capital Adequacy Requirements" in this Section below.
Regulatory compliance requires us to incur ongoing additional expenses. This is
particularly the case with respect to the compliance aspects of the
Sarbanes-Oxley Act and The USA Patriot Act. At times, the cumulative costs of
compliance can be significant.





Sarbanes-Oxley
Act of 2002





The
Sarbanes-Oxley Act of 2002 (“SOX”), imposed new and revised corporate
governance, accounting and reporting requirements on us and all other companies
whose securities are registered with the SEC. SOX established the Public Company
Accounting Oversight Board (“PCAOB”), an accounting oversight board that
enforces auditing standards and restricts the scope of services that accounting
firms may provide to their public company audit clients. SOX addresses
accounting oversight and corporate governance matters, including:





·
            required
      executive certification of financial
  presentations


·
            increased
      requirements for board audit committees and their
  members


·
            enhanced
      disclosure of controls and procedures and internal control over financial
      reporting


·
            enhanced
      controls on, and reporting of, insider
trading


·
            increased
      penalties for financial crimes and forfeiture of executive bonuses in
      certain circumstances


·
            the
      prohibition of accounting firms from providing various types of consulting
      services to public clients and requiring accounting firms to rotate
      partners among public client assignments every five
  years.





18


USA
PATRIOT Act





The USA
Patriot Act of 2001 and its related regulations require insured depository
institutions, broker-dealers, and certain other financial institutions to have
policies, procedures and controls to detect, prevent and report money laundering
and terrorist financing. Under the USA PATRIOT Act,
financial institutions are subject to prohibitions against specified financial
transactions and account relationships as well as enhanced due diligence and
"know your customer" standards in their dealings with foreign financial
institutions and foreign customers.





This area
has been a particular focus for federal regulators and material deficiencies in
anti-money laundering compliance can result in public enforcement actions by the
banking agencies, including the imposition of civil money penalties and
supervisory restrictions on growth and expansion. Such actions could have
serious reputation consequence for our company and our bank.





Customer
Information Security





The
Federal Reserve Bank and other bank regulatory agencies have adopted final
guidelines to protect a customer’s confidential and personal information. The
guidelines require the creation and implementation of a comprehensive written
program to protect: (i) the security and confidentiality of customer
information; (ii) against threats or hazards to the security or integrity of
such information; and (iii) against unauthorized access to or use of such
information. We have adopted and implemented a program to comply with these
requirements.





Consumer
Protection Laws and Regulations




Our bank
is subject to many federal and state consumer protection statutes and
regulations, some of which are discussed below. Examination and enforcement by
the bank regulatory agencies in these areas in the recent past has
intensified.





Privacy
policies are required by federal banking regulations which limit the ability of
banks and other financial institutions to disclose non-public information about
consumers to nonaffiliated third parties. Pursuant to those rules, financial
institutions must provide initial notices to customers about their privacy
policies, annual notices of their privacy policies to current customers; and a
reasonable method for customers to “opt out” of disclosures to nonaffiliated
third parties. These privacy protections affect how consumer information is
transmitted through diversified financial companies and conveyed to outside
vendors. In addition, state laws may impose more restrictive limitations on the
ability of financial institution to disclose such information. California has
adopted such a privacy law that among other things generally provides that
customers have certain options relative to the disclosure of information to
third parties.





The Fair
Credit Reporting Act, as amended by the Fair and Accurate Credit Transactions
Act, or “FACT Act”, requires financial firms to help deter identity theft,
including developing appropriate fraud response programs, and gives consumers
more control of their credit data. It also reauthorizes a federal ban on state
laws that interfere with corporate credit granting and marketing practices and
provides consumer’s election to opt out. We are also subject, in connection with
our lending activities, to numerous federal and state laws aimed at protecting
consumers including the Equal Credit Opportunity Act, the Truth in Lending Act,
the Fair Housing Act, the Community Reinvestment Act, the Home Mortgage
Disclosure Act, and the Real Estate Settlement Procedures Act.





Safety
and Soundness Standards





In
addition to measures taken under the prompt corrective action provisions,
commercial banking organizations may be subject to potential enforcement actions
by the federal and/or state regulators for unsafe or unsound practices in
conducting their businesses or for violations of any law, rule, regulation, or
any condition imposed in writing by the agency or any written agreement with the
agency. The federal banking agencies have adopted guidelines designed to assist
the federal banking agencies in identifying and addressing potential safety and
soundness concerns before capital becomes impaired. In addition, the federal
banking agencies have also adopted safety and soundness guidelines with respect
to asset quality and earnings standards. These guidelines provide standards for
establishing and maintaining a system to identify problem assets and prevent
those assets from deteriorating.


19


Recent
Regulatory Developments





From time
to time, legislation is enacted which has the effect of increasing the cost of
doing business, limiting or expanding permissible activities or affecting the
competitive balance between banks and other financial institutions. Proposals to
change the laws and regulations governing the operations and taxation of banks
and other financial institutions are frequently made in Congress, in the
California legislature and by various bank regulatory agencies.





Changes
to federal and state laws and regulations (including changes in interpretation
or enforcement) can affect the operating environment of bank holding companies
and their subsidiaries in substantial and unpredictable ways. From time to time,
various legislative and regulatory proposals are introduced. These proposals, if
codified, may change banking statutes and regulations and our company’s
operating environment in substantial and unpredictable ways. If codified, these
proposals could increase or decrease the cost of doing business, limit or expand
permissible activities or affect the competitive balance among banks, savings
associations, credit unions and other financial institutions. We cannot
accurately predict whether those changes in laws and regulations will occur,
and, if those changes occur, the ultimate effect they would have upon our
financial condition or results of operations. It is likely, however, that the
current high level of enforcement and compliance-related activities of federal
and state authorities will continue and potentially increase.





The Basel Committee on Banking
Supervisions-“BASEL II”.Regulatory capital guidelines, originally
published in June 2005 and adopted in final form by U.S. regulatory agencies in
November 2007, are designed to promote improved risk measurement and management
processes and better align minimum capital requirements with risk. The Basel II
guidelines are to become operational in April 2008, but are mandatory only for
banks with consolidated total assets of $250 billion or more or consolidated
on-balance sheet foreign exposures of $10 billion or more. They are thus not
applicable to our bank, which continues to operate under U.S. risk-based capital
guidelines consistent with “Basel I” guidelines published in 1988.





Federal
regulators issued for public comment in December 2006 proposed rules (designated
as “Basel IA” rules) applicable to non-core banks that would have modified the
existing U.S. Basel I based capital framework. The regulators announced in
November 2007, however, that instead of the Basel IA proposals, a new rule
making was being prepared involving a “standardized approach” that would
implement some of the simpler approaches for both credit risk and operational
risk from the more advanced Basel II framework. Smaller U.S. depository
institutions would be allowed to elect to remain under the existing Basel-I
based regulatory capital framework. The new rule making is expected to be
published in the first half of 2008.





Capital
Adequacy Requirements





The
federal banking agencies have adopted regulations establishing minimum
requirements for capital adequacy. These agencies may establish higher minimum
requirements if, for example, a bank or company previously has received special
attention or has a high susceptibility to interest rate risk. Under Federal
Reserve regulations, the minimum ratio of total capital to risk-adjusted assets
is 8%. At least half of the total capital is required to be "Tier I capital,"
principally consisting of qualifying capital securities and minority interests,
less certain goodwill items. The remainder ("Tier II capital") may consist of a
limited amount of subordinated debt, certain hybrid capital instruments and
other debt securities, perpetual preferred stock, and a limited amount of the
allowance for loan loss. In addition to the risk-based capital guidelines, the
Federal Reserve has adopted a minimum Tier I capital (leverage) ratio, under
which a bank holding company must maintain a minimum level of Tier I capital to
average total consolidated assets of at least 3% in the case of a bank holding
company which has the highest regulatory examination rating and is not
contemplating significant growth or expansion. All other bank holding companies
are expected to maintain a Tier I capital (leverage) ratio of at least 1% to 2%
above the stated minimum.





As
of December 31, 2007, our company's capital ratios were as follows:


·
            Tier
      I leverage ratio was 10.63%


·
            Tier
      I risk-based ratio was 9.65%


·
            Total
      risk-based ratio was 10.80%





As of
December 31, 2007, our bank’s capital ratios were as follows:


·
            Tier
      I leverage ratio was 10.48%


·
            Tier
      I risk-based ratio was 9.51%


·
            Total
      risk-based ratio was 10.66%





20


The
current risk-based capital guidelines are based upon the 1988 capital accord of
the International Basel Committee on Banking Supervision. A new international
accord, referred to as Basel II, which emphasizes internal assessment of credit,
market and operational risk, supervisory assessment and market discipline in
determining minimum capital requirements, currently becomes mandatory for large
international banks outside the U.S. in 2008. New rule making is expected in
2008 that would be applicable to us and involve a standardized
approach.





The
federal banking regulators are required to take "prompt corrective action" with
respect to capital-deficient institutions. Agency regulations define, for each
capital category, the levels at which institutions are "well capitalized,"
"adequately capitalized," "under capitalized," "significantly under capitalized"
and "critically under capitalized." A "well capitalized" bank has a total
risk-based capital ratio of 10.0% or higher; a Tier I risk-based capital ratio
of 6.0% or higher; a leverage ratio of 5.0% or higher; and is not subject to any
written agreement, order or directive requiring it to maintain a specific
capital level for any capital measure. An "adequately capitalized" bank has a
total risk-based capital ratio of 8.0% or higher; a Tier I risk-based capital
ratio of 4.0% or higher; a leverage ratio of 4.0% or higher (3.0% or higher if
the bank was rated a composite 1 in its most recent examination report and is
not experiencing significant growth); and does not meet the criteria for a well
capitalized bank. A bank is "under capitalized" if it fails to meet any one of
the ratios required to be adequately capitalized.





In
addition to requiring undercapitalized institutions to submit a capital
restoration plan, agency regulations contain broad restrictions on certain
activities of undercapitalized institutions including asset growth,
acquisitions, branch establishment and expansion into new lines of business.
With certain exceptions, an insured depository institution is prohibited from
making capital distributions, including dividends, and is prohibited from paying
management fees to control persons if the institution would be undercapitalized
after any such distribution or payment.





As an
institution's capital decreases, the federal agency's enforcement powers become
more severe. A significantly undercapitalized institution is subject to mandated
capital raising activities, restrictions on interest rates paid and transactions
with affiliates, removal of management, and other restrictions. A federal agency
has only very limited discretion in dealing with a critically undercapitalized
institution and is virtually required to appoint a receiver or
conservator.





Banks
with risk-based capital and leverage ratios below the required minimums may also
be subject to certain administrative actions, including the termination of
deposit insurance upon notice and hearing, or a temporary suspension of
insurance without a hearing in the event the institution has no tangible
capital.





Our bank
was “well capitalized” according to the guidelines discussed above, as of
December 31, 2007.





Deposit
Insurance Assessments





Our bank's deposits are insured
(presently $100,000 per depositor; $250,000 in the case of certain retirement
accounts) by the Deposit Insurance Fund ("DIF") which is operated by the FDIC.
FDIC insured depository institutions pay insurance premiums at rates based on
their risk classification. On November 2, 2006, the FDIC finalized a rule
intended to match an institution's deposit insurance premium to the risk an
institution poses to the deposit insurance fund. Under the requirements, the
FDIC designates annually a target reserve ratio for the DIF within the range of
1.15 percent and 1.5 percent. The FDIC adopted 1.25 percent as the designated
reserve for 2007. Under the system, each depository institution falls within one
of four risk categories depending on supervisory ratings and financial ratios.
Our bank’s rate fell within the lowest risk category for 2007 and is expected to
fall within this category for 2008. In 2007, the FDIC issued one-time assessment
credits that can be used to offset this expense.





Our bank continues to be required to
pay an assessment fee for the payment of interest on bonds that were issued by
the Financing Corporation (“FICO”) as a means of capitalizing the Federal
Savings and Loan Insurance Corporation. These bonds are commonly known as FICO
bonds. The average rate for 2007 was 1.17 basis points per $100 of deposits. The
current range of DIF assessments is between 15 and 43 basis points per $100 of
domestic deposits. The average rate for our bank was 0.09% for the first quarter
of 2007 and 5.67 basis points per $100 of deposits for the remainder of 2007,
0.0% for 2006 and 2005. We paid $656 thousand of FDIC assessments in 2007, $98
thousand in 2006, and $75 thousand in 2005.





The FDIC is authorized to terminate a
depository institution's deposit insurance upon a finding by the FDIC that the
institution's financial condition is unsafe or unsound or that the institution
has engaged in unsafe or unsound practices or has violated any applicable rule,
regulation, order or condition enacted or imposed by the institution's
regulatory agency.


21


Change
in Control





The BHCA prohibits our company from
acquiring direct or indirect control of more than 5% of the outstanding voting
securities or substantially all the assets of any bank or savings bank, or
merging or consolidations with another bank holding company or savings bank
holding company, without prior approval of the Federal Reserve. Similarly,
Federal Reserve approval (or in certain cases, nondisapproval) must be obtained
before any person acquiring control of a bank holding company. Control is
conclusively presumed to exist if, among other things, a person acquires more
that 25% of any class of voting stock of our company or controls in any manner
the election of a majority of the directors of our company. Control is presumed
to exist if a person acquires more that 10% of any class of voting stock and the
stock is registered under Section 12 of the Exchange Act or the acquirer will be
the largest stockholder after the acquisition.





Examinations





The FRB, through the BHCA, has the
authority to examine and evaluate our company and its subsidiaries. The DFI and
the FDIC periodically examine and evaluate non-member state-chartered banks,
including our bank. These examinations review areas such as capital adequacy,
allowance for loan losses, loan portfolio quality and management, consumer and
other compliance issues, investments and management practices. In addition to
these regular examinations, we are required to furnish quarterly and annual
reports to the FDIC and Federal Reserve. The FDIC and the DFI may exercise cease
and desist or other supervisory powers if actions represent unsafe or unsound
practices or violations of law. Further, any proposed addition of any individual
to the board of directors of a bank or the employment of any individual as a
senior executive officer of a bank, or the change in responsibility of such an
officer, will be subject to prior written notice to the FDIC if a bank is not in
compliance with the applicable minimum capital requirements, is otherwise a
troubled institution or the FDIC determines that such prior notice is
appropriate for a bank. The FDIC then has the opportunity to disapprove any such
appointment.





Federal
Securities Law





Our company has registered its common
stock with the SEC under the Exchange Act. As a result, the proxy and tender
offer rules, insider trading reporting requirements, corporate governance,
annual and periodic reporting and other requirements of the Exchange Act are
applicable to our company.





Transactions
with Insiders and Affiliates





Depository institutions are subject to
the restrictions contained in Section 22(h) of the Federal Reserve Act with
respect to loans to directors, executive officers and principal stockholders.
Under Section 22(h), loans to directors, executive officers and stockholders who
own more than 10% of a depository institution and certain affiliated entities of
any of the foregoing, may not exceed, together with all other outstanding loans
to such person and affiliated entities, the institution's loans-to-one-borrower
limit (as discussed below). Section 22(h) also prohibits loans above amounts
prescribed by the appropriate federal banking agency to directors, executive
officers, and stockholders who own more than 10% of an institution, and their
respective affiliates, unless such loans are approved in advance by a majority
of the board of directors of the institution. Any "interested" director may not
participate in the voting. The prescribed loan amount (which includes all other
outstanding loans to such person), as to which such prior board of director
approval is required, is the greater of $25,000 or 5% of capital and surplus (up
to $500,000). Further, pursuant to Section 22(h), the Federal Reserve requires
that loans to directors, executive officers, and principal stockholders be made
on terms substantially the same as offered in comparable transactions with
non-executive employees of the bank. There are additional limits on the amount a
bank can loan to an executive officer.





Transactions between a bank and its
"affiliates" are quantitatively and qualitatively restricted under the Federal
Reserve Act. The Federal Deposit Insurance Act applies Sections 23A and 23B to
insured nonmember banks, including our bank, in the same manner and to the same
extent as if they were members of the Federal Reserve System. Regulation W
incorporates the exemption from the affiliate transaction rules but expands the
exemption to cover the purchase of any type of loan or extension of credit from
an affiliate. Affiliates of a bank include, among other entities, the bank’s
holding company and companies that are under common control with the bank. Our
company is considered to be an affiliate of our bank.





Regulation W incorporates the exemption
from the affiliate transaction rules but expands the exemption to cover the
purchase of any type of loan or extension of credit from an affiliate.
Affiliates of a bank include, among other entities, the bank's holding company
and companies that are under common control with the bank. Our company is
considered to be an affiliate of our bank.


22


Monetary
Policy





The monetary policies of regulatory
authorities, including the Federal Reserve, have a significant effect on the
operating results of banks. The Federal Reserve supervises and regulates the
national supply of bank credit. Among the means available to the Federal Reserve
to regulate the supply of bank credit are open market purchases and sales of
U.S. government securities, changes in the discount rate on borrowings from the
Federal Reserve, and changes in reserve requirements with respect to deposits.
These activities are used in varying combinations to influence overall growth
and distribution of bank loans, investments, and deposits on a national basis
and their use may affect interest rates charged on loans or paid for
deposits.





Federal Reserve monetary policies and
the fiscal policies of the federal government have materially affected the
operating results of commercial banks in the past and are expected to continue
to do so in the future. We cannot predict the nature of future monetary and
fiscal policies and the effect of such policies on our future business and
earnings.





Subsidiaries





Our bank is a subsidiary of our
company. In September 2003, our company formed Temecula Valley Statutory Trust
II, a Connecticut statutory trust, for the purpose of issuing trust preferred
securities. In September 2004, our company formed Temecula Valley Statutory
Trust III, a Delaware statutory trust, for the purpose of issuing trust
preferred securities. In September 2005, our company formed Temecula Valley
Statutory Trust IV, a Delaware statutory trust, for the purpose of issuing trust
preferred securities. In September 2006, our company formed Temecula Valley
Statutory Trust V, a Delaware statutory trust, for the purpose of issuing trust
preferred securities. In December 2007, our company formed Temecula Valley
Statutory Trust VI, a Delaware statutory trust, for the purpose of issuing trust
preferred securities in 2008.





Environmental
Concerns





We are
not involved in manufacturing or the use or transportation of hazardous
materials that might have a material adverse effect on the environment. Our
principal exposure to any hazardous material risk is through our lending
activities and through properties or businesses we may own, lease or acquire.
Based on a general survey of our bank’s loan portfolio and the real property we
lease and own in the operation of our business, we are not aware of any
potential liability for hazardous waste contamination that would be reasonably
likely to have a material adverse effect on our company as of the date of this
report.





Employees





As of December 31, 2007, we had
325 employees (316 full time equivalent), of which 296 are full time.
Approximately one third of our employees are directly involved in the
origination, underwriting, and processing of SBA loans. Additional support staff
is required to service the SBA loans after they are funded. There are no
employees at our company. Our employees are not represented by any collective
bargaining group. We consider our relations with our employees to be
satisfactory.





Available
Information





We do not make available on our website
our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports
on Form 8-K, or proxy statements for our annual shareholders meetings, or the
amendments to those reports although there is a hyper-link at our website at
www.temvalbank.com
through the “Investor Relations-SEC Filings” page to the SEC website at www.sec.gov  that
contains reports, proxy statements, and other information regarding SEC
registrants including our company. None of the information contained in our
website or hyper-linked from our website is incorporated into this Form 10-K. We
have not provided this information directly on our website because of the ease
of accessing the information through our website to the SEC website. All of our
annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K, and proxy statements for our annual shareholders meeting as well as
the amendments to those reports may be obtained free of charge by contacting
Donald Pitcher at (951)939-3736 as soon as possible after we have filed
electronically with the SEC. You may read and copy any materials filed with the
SEC at the SEC’s Public Reference Room at 100 F. Street NE., Washington DC
20549. You may obtain information on the operation of the Public Reference Room
by calling the SEC at 1-800-SEC-0330.


23


ITEM
1A:                      RISK
FACTORS





Our
dependence on loans secured by real estate subjects us to risks relating to
fluctuations in the real estate market and related interest rates, environmental
risks, and legislation that could result in significant additional costs and
capital requirements that could adversely affect our assets and results of
operations.





There has been a slowdown in the real
estate market due to credit market turmoil, the depth or complete effect of
which is unknown. A significant portion of our loan portfolio is secured by real
estate. Real estate served as the principal source of collateral with respect to
approximately 92% and 94% of our loan portfolio at December 31, 2007 and
December 31, 2006, respectively. During 2007, real estate markets in California
and elsewhere experienced, in most cases, a modest to significant depreciation.
A sustained or sudden significant decline in economic conditions or rising
interest rates could have an adverse effect on the demand for new loans, the
ability of borrowers to repay outstanding loans, the value of real estate and
other collateral securing loans, and the value of real estate owned by us, as
well as our financial condition and results of operations in general and the
market value of our common stock. We have instituted stricter underwriting
criteria which may further impact downward values.





In the course of business, we may
acquire, through foreclosure, properties securing loans that are in default. In
commercial real estate lending, there is a risk that hazardous substances could
be discovered on these properties. In this event, we might be required to remove
these substances from the affected properties at our sole cost and expense. The
cost of this removal could substantially exceed the value of affected
properties. We may not have adequate remedies against the prior owner or other
responsible parties or could find it difficult or impossible to sell the
affected properties, which could adversely affect our business, financial
condition and operating results.





Our bank's concentration in real
estate construction loans subjects it to risks such as inadequate security for
repayment of those loans and fluctuations in the demand for those loans based on
changes in the housing market.





We have a
high concentration in real estate construction loans. Approximately 47% and 50%
of our lending portfolio was classified as real estate construction loans as of
December 31, 2007 and December 31, 2006, respectively. Our real estate
construction loans are based upon estimates of costs and value associated with
the completed project. These estimates may be inaccurate. Construction lending
involves additional risks when compared to permanent residential lending because
funds are advanced upon the security of the project, which is of uncertain value
prior to its completion. Because of the uncertainties inherent in estimating
construction costs, the market value of the completed project and the effects of
governmental regulation of real property, it is relatively difficult to
accurately determine the total funds required to complete a project and the
related loan-to-value ratio.





Construction
lending also typically involves higher loan principal amounts and is often
concentrated with a small number of builders. In addition, generally during the
term of a construction loan, no payment from the borrower is required since the
accumulated interest is added to the principal of the loan through an interest
reserve. Construction loans often involve the disbursement of substantial funds,
with repayment substantially dependent on the success of the ultimate project
and the ability of the borrower to sell or lease the property or obtain
permanent take-out financing, rather than the ability of the borrower or
guarantor to repay principal and interest. If our appraisal of the value of the
completed project proves to be overstated, we may have inadequate security for
the repayment of the loan upon completion of construction and may incur a
loss.





Our
ability to continue to originate a significant amount of construction loans is
dependent on the housing market in the Riverside, San Bernardino, and San Diego
County regions of Southern California and in the San Francisco Bay area. To the
extent there is a continued decline in the demand for new housing in these
communities, we expect that the demand for construction loans will continue to
decline, our liquidity will substantially increase and our net income will be
adversely affected.





Our
earnings are highly dependent on our continued ability to originate, sell and
service SBA loans.





Our
earnings are highly dependent on our ability to generate new SBA loans, as our
net income generated from our SBA activities is significant. Increases in
interest rates and other economic conditions could result in decreased SBA loan
demand as well as lower gains on sale.





SBA lending is a federal government
created and administered program. As such, legislative and regulatory
developments can affect the availability and funding of the program. This
dependence on legislative funding and regulatory restrictions from time to time
causes limitations and uncertainties with regard to the continued funding of
such loans, with a resulting potential adverse financial impact on our business.
Currently, the maximum limit on individual 7(a) loans which the SBA will permit
is $2 million. Any reduction in this level


24


could
adversely affect the volume of our business. Since our SBA business constitutes
a significant portion of our lending program, our dependence on this government
program and its periodic uncertainty relative to availability and amounts of
funding creates greater risk for our business than do more stable aspects of our
business.





We
may incur additional costs and experience impaired operating results if we are
unable to retain our key management or we are unable to attract and retain
additional successful bankers in order to grow our business.





Stephen H. Wacknitz has been the
president and chief executive officer of our holding company and our bank since
the inception of both entities. Mr. Wacknitz and our executive management team
developed numerous aspects of our current business strategy, and the
implementation of that strategy depends heavily upon the active involvement of
Mr. Wacknitz and our executive management team. The loss of the services of Mr.
Wacknitz or other senior officers who are part of our succession planning could
adversely affect our business strategy and could cause us to incur additional
costs and experience impaired operating results while we seek suitable
replacements. Additionally, because our business model depends on hiring
successful bankers that generally bring to us additional customers, if we are
unsuccessful in continuing to attract and retain producers, our growth may be
impaired and the results of our operations adversely affected.





If
our bank is unable to pay our holding company cash dividends to meet its cash
obligations, our business, financial condition, results of operations and
prospects will be adversely affected.





Dividends
paid by our bank to our holding company provide cash flow used to service the
interest payments on our trust preferred securities. Various statutory
provisions restrict the amount of dividends our bank can pay to our holding
company without regulatory approval. It is possible, depending upon the
financial condition of our bank and other factors, that the applicable
regulatory authorities could assert that payment of dividends or other payments,
including payments to our holding company, is an unsafe or unsound practice. If
our bank is unable to pay dividends to our holding company, our holding company
may not be able to service its debt or pay its obligations. Our holding
company's inability to receive dividends from our bank would adversely affect
our business, financial condition, results of operations and
prospects.





Our
ability to pay cash dividends is restricted by law and contractual
arrangements.





Dividends we pay to our shareholders
are restricted by California law and under indentures governing trust preferred
securities we have issued. We cannot assure you that we will meet the criteria
specified under California law or under these indentures in the future which
could result in a decrease in the amount of or complete elimination of dividends
we pay to our shareholders.





Our
allowance for loan losses may prove to be insufficient to absorb losses inherent
in our loan portfolio.





Like all
financial institutions, we maintain an allowance for loan losses to provide for
loan defaults and non-performance and a reserve liability for unfunded loan
commitments. The amount of future losses is susceptible to changes in economic,
operating and other conditions, including changes in interest rates that may be
beyond our control and losses may exceed current estimates. Although management
believes the level of our loan loss allowance is adequate to absorb probable
losses in our loan portfolio, management cannot predict losses or whether the
allowance will be adequate or whether regulators will require us to increase
this allowance. Any of these occurrences could adversely affect our business,
financial condition, prospects and profitability.





Our
bank’s loan losses as a percentage of net loans outstanding and loans
held-for-sale was 1.29% as of December 31, 2007, 1.10% as of December 31, 2006
and 1.20% as of December 31, 2005. The allowance for loan losses as a percentage
of net loans outstanding, excluding loans held-for-sale, was 1.56% as of
December 31, 2007, 1.29% as of December 31, 2006 and 1.35% as of December 31,
2005.





Our
bank's business, financial condition and results of operations are sensitive to
and may be adversely affected by interest rate and prepayment
changes.





Our earnings are substantially affected
by changes in prevailing interest rates. Changes in interest rates affect the
demand for new loans, the credit profile of existing loans, the rates received
on loans and securities and the rates we must pay on deposits and borrowings.
The difference between the rates we receive on loans and short-term investments
and the rates we must pay on deposits and borrowings is known as the interest
rate spread. Given our current volume and mix of interest-bearing assets and
liabilities, our interest rate spread can be expected to increase when market
interest rates are rising, and to decline when market interest rates are
declining. Although we believe our current level of interest rate sensitivity


25


is
reasonable, significant fluctuations in interest rates may adversely affect our
business, financial condition and results of operations. While an increase in
interest rates generally should positively affect our net interest margin, it
may also cause borrowers with variable loan rates to have difficulty paying
their loans and this may have the affect of lowering our loan volume and
profits.





In
addition, the value of our SBA servicing asset and SBA I/O strip receivable,
which totaled $5.4 million and $6.6 million, respectively, at December 31, 2007,
and $8.3 million and $13.2 million, respectively, at December 31, 2006, are
subject to fluctuations based on changes in interest rates and prepayment
speeds. Generally, we would expect the value of our SBA servicing asset to
decrease in a rising interest rate environment, as well as if prepayment speeds
increase. Similarly, the value of our SBA interest-only strip receivable asset
is subject to fluctuations in prepayment speeds and would be expected to
decrease if prepayment speeds increase.





Increasing
levels of competition in banking and financial services businesses may reduce
our market share or cause the prices we charge for services to fall, which may
decrease our profits.





Competition may adversely affect our
results of operations. The financial services business in our market area is
highly competitive and becoming more so due to changes in regulation,
technological advances, and the accelerating pace of consolidation among
financial service providers and out-of-state financial institutions and
intermediaries. We face competition both in attracting deposits and making
loans. We compete for loans principally through competitive interest rates and
the efficiency and quality of the services we provide. Increased competition in
the banking and financial services businesses may reduce loans and deposits or
cause the prices we charge for services to fall. Many of the financial
intermediaries operating in our market area offer certain services, such as
trust, investment, and international banking services, that we do not offer
directly, and may have larger lending limits than ours, which may prompt
existing or potential customers to do business with our competitors instead of
us.





The
recent credit market disruption has decreased market liquidity and increased
competition. This has caused rates on certain deposit accounts to trend upward
while market interest rates have declined.To
maintain adequate liquidity levels, we will likely incur additional deposit
costs.





Our
success depends, in part, upon our ability to effectively use rapid-changing
technology in providing and marketing products and services to our
customers.





The
financial services industry is undergoing rapid technological changes, with
frequent introductions of new technology-driven products and services. The
effective use of technology increases efficiency and enables financial
institutions to better serve customers and to reduce costs. Our future success
will depend, in part, upon our ability to use technology to provide products and
services that will satisfy customer demands for convenience, as well as to
create additional efficiencies in our operations and compliance with regulatory
expectations. Many of our competitors have substantially greater resources to
invest in technological improvements. We may not be able to effectively
implement new technology-driven products and services or be successful in
marketing those products and services to our customers.





We have not been
through a variety of business cycles since we began operations and, as a result, we
may not effectively evaluate our future prospects and this lack of operating history
may increase the risk that we will not continue to be
successful.





We began
operations in 1996 and since that time the markets in which we conduct business
have, until recently, experienced substantial economic growth. As a result, we
do not have an operating history during a serious downturn in the real estate
market for you to evaluate our performance relative to future prospects. You
must consider our business and prospects in light of the risks and difficulties
we will encounter if the economies of San Diego, Riverside or the
San Francisco Bay area experience a severe downturn, greater than what is
currently taking place. We may not be able to address these risks and
difficulties successfully, which could have material adverse consequences on our
business and operating results.





We may be
required to raise additional capital in the future, but that
capital may not be available or may not be on terms acceptable to us
when it is
needed.





We are
required by federal regulatory authorities to maintain adequate levels of
capital to support our operations. We may decide to raise additional capital to
support growth, either internally or through acquisitions. In addition, the use
of brokered deposits without regulatory approval is limited to banks that are
“well capitalized” according to regulation. If we are unable to maintain our
capital levels at “well capitalized” minimums, we could lose a significant
source of funding, which would force us to utilize additional wholesale funding
or


26


potentially
sell loans at a time when loan sales pricing is unfavorable. Our ability to
raise additional capital, if needed, will depend on conditions in the capital
markets at that time, which are outside our control, and on our financial
performance. Accordingly, we cannot be certain of our ability to raise
additional capital in the future if needed or on terms acceptable to us. If we
cannot raise additional capital when needed, our ability to further expand our
operations through internal growth, deposit gathering and acquisitions could be
materially impaired.





Both
our holding company and our bank are subject to government regulation that
limits and restricts their activities and operations.





The financial services industry is
heavily regulated, and the regulatory burden on banks is increasing. Federal and
state regulation is designed to protect the deposits of consumers, not to
benefit shareholders. Applicable laws and regulations impose significant
limitations on operations, and may change at any time, possibly causing results
to vary significantly from past results including: (i) compliance expense
increases or compliance difficulties; or (ii) adverse affects on loan or deposit
pricing. Government policy and regulation, particularly as implemented through
the Federal Reserve System, significantly affect our credit
conditions.





Our
business, financial condition and results of operations may be adversely
affected if we are unable to insure against or control our operations
risks.





We are subject to various operations
risks, including, but not limited to, data processing system failures and
errors, communications and information systems failures, errors and breaches,
customer or employee fraud, and catastrophic failures resulting from terrorist
acts or natural disasters. Should an event occur that is not prevented or
detected by our internal controls, or is uninsured or in excess of applicable
insurance limits, it could damage our reputation, result in a loss of customer
business, cause additional regulatory scrutiny, and expose us to litigation
risks and possible financial liability, any of which could adversely affect our
business, financial condition and results of operations.





Our business is
subject to liquidity risk, and changes in our source of funds may adversely affect
our performance and financial condition by increasing our cost of
funds.





Our
ability to make loans is directly related to our ability to secure funding. Core
deposits are our primary source of liquidity. Also, we use the national
certificate of deposit (“CD”) markets, which are generally CDs purchased by
other financial institutions and brokered CDs. Both the national CD market and
brokered CDs are rate sensitive and generally have a higher rate than deposits
generated in our local markets. We use advances from the Federal Home Loan Bank
of San Francisco and Federal Fund lines of credit to satisfy temporary borrowing
needs. Payments of principal and interest on loans and sales and participations
of eligible loans are also a primary source for our liquidity needs. Primary
uses of funds include withdrawal of and interest payments on deposits,
originations and purchases of loans, and payment of operating expenses. Core
deposits represent significant sources of low-cost funds. Alternative funding
sources, such as large balance time deposits or borrowings, are a comparatively
higher-costing source of funds. Liquidity risk arises from the inability to meet
obligations when they come due or to manage the unplanned decreases or changes
in funding sources. Although we believe we can continue to successfully pursue
our core deposit funding strategy, significant fluctuations in core deposit
balances may adversely affect our financial condition and results of
operations.





Future
sales of our stock by our shareholders or the perception that those sales could
occur may cause our stock price to decline.





Although
our common stock is listed for trading on The NASDAQ Global Select Market, the
trading volume in our common stock is lower than that of other larger financial
services companies. A public trading market having the desired characteristics
of depth, liquidity and orderliness depends on the presence in the marketplace
of willing buyers and sellers of our common stock at any given time. This
presence depends on the individual decisions of investors and general economic
and market conditions over which we have no control. Given the relatively low
trading volume of our common stock, significant sales of our common stock in the
public market, or the perception that those sales may occur, could cause the
trading price of our common stock to decrease or to be lower than it otherwise
might be in the absence of those sales or perceptions.


27


The existence of outstanding stock
options issued to our directors, executive officers and employees may result in
dilution of your ownership and adversely affect the terms on which we can obtain
additional capital.


As of
December 31, 2007, we had outstanding options to purchase 1,177,413 shares of
our common stock at a weighted average exercise price of $10.49 per share. All
of these options are held by our directors, executive officers and employees.
The issuance of shares subject to options under the plans may result in dilution
of your ownership of our common stock.





The exercise of stock options could
also adversely affect the terms on which we can obtain additional capital.
Option holders are most likely to exercise their options when the exercise price
is less than the market price for our common stock. They profit from any
increase in the stock price without assuming the risks of ownership of the
underlying shares of common stock by exercising their options and selling the
stock immediately.





A
natural disaster could harm our business.





Historically, California, in which a
substantial portion of our business is located, has been susceptible to natural
disasters, such as earthquakes, floods and wildfires. These natural disasters
could harm our operations through interference with communications, including
the interruption or loss of our computer systems, which could prevent or impede
us from gathering deposits, originating loans and processing and controlling the
flow of business, as well as through the destruction of facilities and our
operational, financial and management information systems. Additionally, natural
disasters could negatively impact the values of collateral securing our loans
and interrupt our borrowers’ abilities to conduct their businesses in a manner
to support their debt obligations, either of which could result in losses and
increased provisions for credit losses.





The risks
described in this report are not the only risks we face. Additional risks and
uncertainties not currently known to us or that we currently deem to be
immaterial also may materially adversely affect our business, financial
condition and/or operating results.





ITEM
1B:                      UNRESOLVED STAFF
COMMENTS





None





ITEM
2:                      PROPERTIES





We conduct business at eleven
full-service banking offices in Southern California and multiple loan production
offices in twelve states, including California. The main office facilities are
located at 27710 Jefferson Avenue, Suite A100, Temecula, California. As of
December 31, 2007, we owned the property at one of our branch locations. The
remaining banking offices and other offices are leased. Most of the leases
contain multiple renewal options and provisions for rental increases,
principally for changes in the cost of living index, property taxes and
maintenance. Total future annual rental payments (exclusive of operating charges
and real property taxes) are approximately $5.0 million, with lease expiration
dates ranging from 2008 to 2014, exclusive of renewal options.





At
December 31, 2007, our consolidated investment in premises and equipment, net of
accumulated depreciation and amortization, totaled $5.3 million. Total occupancy
expense was $3.2 million.





We
believe that our existing facilities are adequate for our present purposes and
that the properties are adequately covered by insurance.





ITEM
3:                      LEGAL
PROCEEDINGS





From time to time, we are involved in
legal proceedings arising in the normal course of business. After taking into
consideration information furnished by counsel to our company and bank, we do
not believe that there is any pending or threatened proceeding against our
company or our bank which, if determined adversely, would have a material effect
on our business, financial condition or results of operation.





We are not aware of any material
proceedings to which any director, officer or affiliate of our company, any
owner of record or beneficially of more than 5% of the voting securities of our
company as of December 31, 2007, or any associate of any such director, officer,
affiliate of our company, or security holder is a party adverse to our company
or any of its subsidiaries or has a material interest adverse to our company or
any of its subsidiaries.


28


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





No matters were submitted to a vote of
security holders during the fourth quarter of the year ended December 31,
2007.





PART II




ITEM 5.  MARKET FOR REGISTRANT’S
COMMONEQUITY,
RELATED SHAREHOLDER MATTERSAND ISSUER PURCHASES OF
EQUITY SECURITIES







Trading
Information





Our company’s common stock is listed on
The NASDAQ Stock Market LLC under the symbol TMCV. The following table
summarizes the high and low sales prices for each quarterly period ended since
January 1, 2006 for our common stock, as quoted and reported by The NASDAQ Stock
Market.





Two
      Year Summary of Common Stock PricesQuarter
      Ended
            
            High
            
            Low
            
            Dividends03/31/2006
            
            $23.92
            
            $19.16
            
            N/A06/30/2006
            
            $24.00
            
            $19.85
            
            N/A09/30/2006
            
            $25.00
            
            $19.85
            
            N/A12/31/2006
            
            $23.86
            
            $20.15
            
            N/A03/31/2007
            
            $23.73
            
            $21.26
            
            N/A06/30/2007
            
            $21.60
            
            $17.69
            
            $0.04
      cash dividend09/30/2007
            
            $18.35
            
            $15.76
            
            $0.04
      cash dividend12/31/2007
            
            $17.51
            
            $10.03
            
            $0.04
      cash dividend





As of March 7, 2008, the closing sale
price of our company’s stock, as reported by The NASDAQ Stock Market was $9.71.
As of March 31, 2008, there were approximately 408 record holders of our
company’s common stock. Directors and executive officers owned approximately
15.3% of our outstanding shares.





Dividends





Our company is a legal entity separate
and distinct from our bank. Our company’s shareholders are entitled to receive
dividends when and as declared by our Board of Directors, out of funds legally
available therefore, subject to the restrictions set forth in the California
General Corporation Law as well as other restrictions discussed
below.





The
availability of operating funds for our company and the ability of our company
to pay a cash dividend depends largely on our bank’s ability to pay a cash
dividend to our company. The payment of cash dividends by our bank is subject to
restrictions set forth in various federal and state laws and regulations. In
addition, our ability to pay dividends to our shareholders is limited by certain
covenants contained in the indentures governing trust preferred securities
issued by us and the debentures underlying the trust preferred securities.
The indentures
provide that if an Event of Default (as defined in the indentures) has occurred
and is continuing, or if we are in default with respect to any obligations under
our guarantee agreement which covers payments of the obligations on the trust
preferred securities, or if we give notice of any intention to defer payments of
interest on the debentures underlying the trust preferred securities, then we
may not, among other restrictions, declare or pay any dividends (other than a
dividend payable by the bank to our company) with respect to our common stock.
See “Item 7.MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS – Financial Condition – Capital.”





Our
primary source of income is the receipt of dividends from our bank. The
availability of dividends from our bank is limited by various statutes and
regulations. It is possible, depending upon the financial condition of our bank,
and other factors, that the Federal Reserve, the FDIC or the DFI could assert
that payment of dividends or other payments is an unsafe or unsound practice.
Our bank is subject to restrictions under certain federal and state laws and
regulations governing banks which limit its ability to transfer funds to the
holding company through intercompany loans, advances or cash dividends.
Dividends paid by state banks such as our bank are regulated by the DFI under
its general supervisory authority as it relates to a bank's capital
requirements. A state bank may declare a dividend without the approval of the
DFI as long as the total dividends declared in a calendar year do not exceed
either the retained earnings or the total of net earnings for three previous
fiscal years less any dividend paid during such period. During 2007, we received
dividends of $13.0 million from


29


our bank.
At December 31, 2007, our bank's retained earnings totaled $64.7 million Of this amount,
$37.5 million may be dividended to the holding company without regulatory
approval. In January 2008, the bank paid a dividend to the holding
company of $13.0 million. See "Item 7. MANAGEMENT DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – Financial
Condition – Liquidity
Management" and Note O of the Notes to Consolidated Financial Statements
contained in "Item 8. Financial Statements and Supplementary Data."





Holders
of our common stock are entitled to receive dividends declared by our board of
directors out of funds legally available under state law governing us and
certain federal laws and regulations governing the banking and financial
services business. During 2007 we paid $807 thousand in cash dividends on common
stock. There were no cash dividends paid for the years 2006 and 2005. Since
January 2007, we have declared the following quarterly dividends:





Record
      Date
            Pay
      Date
            Amount
      per ShareJuly
      2, 2007
            July
      16, 2007
            $0.04October
      1, 2007
            October
      15, 2007
            $0.04




We can
provide no assurance that we will continue to declare dividends on a quarterly
basis or otherwise. The declaration of dividends by us is subject to the
discretion of our board of directors. Our board of directors will take into
account such matters as general business conditions, our financial results,
capital requirements, contractual, legal and regulatory restrictions on the
payment of dividends by us to our shareholders or by our subsidiary to the
holding company, and such other factors as our board of directors may deem
relevant.




Recent
Sales of Unregistered Securities and Use of Proceeds





None


30


Securities
Authorized for Issuance Under Equity Compensation Plans




The
following table provides information as of December 31, 2007, regarding
securities issued and to be issued under our equity compensation plans that were
in effect during fiscal 2007:




Plan
      Category
            
            Plan
      Name
            
            Number
      of Securities to be Issued Upon Exercise of Outstanding Options, Warrants
      and Rights
            
            Weighted-Average
      Exercise Price of Outstanding Options, Warrants and Rights
            
            Number
      of Securities Remaining Available for Future Issuance Under Equity
      Compensation Plans (Excluding Securities Reflected in Column
      (a)(a)
            
            (b)
            
            (c)Equity
      compensation plans approved by security holders
            
            Temecula Valley Bank,
      N.A. 1996 Incentive and Nonqualified Stock Option Plan (Employees) (1)
            
            1,161,292
            
            
            $
            10.24
            
            -Equity
      compensation plans approved by security holders
            
            Temecula Valley Bank,
      N.A. 1997 Nonqualified Stock Option Plan (Directors) (2)
            
            549,876
            
            
            $
            4.43
            
            -Equity
      compensation plans approved by security holders
            
            Temecula Valley
      Bancorp Inc. 2004 Stock Incentive Plan (3)
            
            466,245
            
            
            $
            17.74
            
            180,884Total
            
            2,177,413
            
            
            $
            10.49
            
            180,884Equity
      compensation plans not approved by security holders
            
            None
            
            -
            
            
            $
            -
            
            -(1)
            The
      Temecula Valley Bank, N.A. 1996 Incentive and Nonqualified Stock Option
      Plan (Employees) (the "1996 Plan") was last approved by the shareholders
      of the Bank the 1996 Annual Meeting of Shareholders and amended by our
      shareholders at a meeting in 2001. The 1996 Plan became an obligation of
      our company in 2002.(2)
            The
      Temecula Valley Bank, N.A. 1997 Nonqualified Stock Option Plan (Directors)
      (the “1997 Bank Plan”) was last approved by the shareholders of the bank
      at our 1996 Annual Meeting of Shareholders and amended by our shareholders
      at a meeting in 1997. The 1997 Plan became an obligation of our company in
      2002.(3)
            The
      Temecula Valley Bancorp Inc. 2004 Stock Incentive Plan (the "2004 Plan")
      was last approved by the shareholders of the Company at our 2004 Annual
      Meeting of Shareholders.





Repurchases
of Common Stock





On May
22, 2007, we announced a program to repurchase up to $5.5 million (approximately
250,000 shares) of our company’s common stock in the open market, for a period
of six months ending November 22, 2007. On July 23, 2007, we announced a second
program to repurchase up to $10.0 million (approximately 606,060 shares) of our
company’s common stock in the open market, for a period of six months ending
January 20, 2008.





Issuer
      Purchases of Equity SecuritiesPeriod
            
            ( a
      )
              Total
      number of shares purchased
            
            ( b
      )
              Average
      price paid per share
            
            ( c
      )
              Total
      number of shares purchased as part of publicly announced plans or
      programs
            
            ( d
      )
              Maximum approximate
      dollar value that may yet be purchased under the plans or
      programs1st
      Quarter 2007
            
            -
            
            
            $
            -
            
            
            -
            
            
            $
            -2nd
      Quarter 2007
            
            106,900
            
            
            $
            19.53
            
            
            106,900
            
            
            $
            3,412,6253rd
      Quarter 2007
            
            577,200
            
            
            $
            17.28
            
            
            577,200
            
            
            $
            3,438,3064th
      Quarter 2007
            
            -
            
            
            $
            -
            
            
            -
            
            
            $
            3,438,306684,100
            (1)
            
            $
            17.63
            (2)
            
            684,100
            (1)
            
            $
            3,438,3061)
      All shares repurchased pursuant to two stock repurchase programs publicly
      announced on May 22, 2007 and July 23, 2007.All
      repurchases were made in open market transactions.2)
      This price includes a commission of $0.05 per share.





31


Stock
Performance Graph





The
following graph shows a comparison of stockholder return on our common stock
based on the market price of the common stock with cumulative total returns for
companies in the (i) NASDAQ Composite Index, (ii) the NASDAQ Bank Index, and
(iii) the SNL Bank and Thrift Index, for the 5-year period beginning on
December 31, 2002 though December 31, 2007. The comparison assumes $100 was
invested on December 31, 2002, in our common stock and the comparison groups and
assumes the reinvestment of all cash dividends prior to any tax effect and
retention of all stock dividends. This graph is historical only and may not be
indicative of possible future performance in the common stock. Also, we need to
indicate by a footnote to the table or otherwise "Source: SNL Financial LC,
Charlottesville, VA, (434) 977-1600, www.snl.com".





Period
      EndingIndex
            12/31/02
            12/31/03
            12/31/04
            12/31/05
            12/31/06
            12/31/07Temecula
      Valley Bancorp Inc.
            100.00
            213.44
            280.63
            360.00
            371.54
            186.92NASDAQ
      Composite
            100.00
            150.01
            162.89
            165.13
            180.85
            198.60NASDAQ
      Bank
            100.00
            129.93
            144.21
            137.97
            153.15
            119.35SNL
      Bank and Thrift
            100.00
            135.57
            151.82
            154.20
            180.17
            137.40


32


ITEM
6.                      SELECTED FINANCIAL
DATA





The following table represents selected
financial information for the five years ended December 31, 2007 for our company
and subsidiaries on a consolidated basis. This table should be read in
conjunction with our financial statements and related notes. All share and per
share data have been restated to reflect the two-for-one stock split in December
2003.





TEMECULA
      VALLEY BANCORP INC.Selected
      Financial DataFor
      the Year Ended December 31,2007
            2006
            2005
            2004
            2003Income
      Statement:
            (dollars
      and shares in thousands, except per share data)Interest
      income
            $
            115,615
            $
            94,229
            $
            58,125
            $
            33,615
            $
            23,891Interest
      expense
            
            49,983
            
            34,449
            
            14,584
            
            6,415
            
            4,947Net
      interest income
            
            65,632
            
            59,780
            
            43,541
            
            27,200
            
            18,944Provision
      for loan losses
            
            4,600
            
            3,650
            
            2,897
            
            3,821
            
            1,022Net
      interest income
              after
      provision for loan losses
            
            61,032
            
            56,130
            
            40,644
            
            23,379
            
            17,922Non
      interest income
            
            16,388
            
            19,444
            
            23,822
            
            28,698
            
            24,481Non
      interest expense
            
            51,905
            
            46,991
            
            40,627
            
            33,963
            
            29,121Income
      before income taxes
            
            25,515
            
            28,583
            
            23,839
            
            18,114
            
            13,282Provision
      for income taxes
            
            10,377
            
            11,663
            
            9,886
            
            7,536
            
            5,428Net
      income
            $
            15,138
            $
            16,920
            $
            13,953
            $
            10,578
            $
            7,854Per
      Share Data:Basic
      earnings per share
            $
            1.45
            $
            1.83
            $
            1.58
            $
            1.24
            $
            1.00Diluted
      earnings per share
            $
            1.41
            $
            1.73
            $
            1.46
            $
            1.13
            $
            0.89Cash
      dividends declared per common share
            $
            0.12
            
            N/A
            
            N/A
            
            N/A
            
            N/AAverage
      common shares outstanding
            
            10,411
            
            9,235
            
            8,846
            
            8,503
            
            7,824Average
      common shares (dilutive)
            
            10,767
            
            9,798
            
            9,589
            
            9,364
            
            8,862Book
      value per share
            $
            10.64
            $
            9.75
            $
            6.54
            $
            4.90
            $
            3.64Equity
      shares-beginning balance
            
            10,587
            
            8,898
            
            8,753
            
            8,152
            
            7,447Warrants
      – Shares Issued
            
            -
            
            -
            
            -
            
            -
            
            324Options
      – Shares Issued
            
            245
            
            288
            
            145
            
            601
            
            381Stock
      offering
            
            -
            
            1,401
            
            -
            
            -
            
            -Repurchase-retirement
      of stock
            
            (684)
            
            -
            
            -
            
            -
            
            -Equity
      shares-ending balance
            
            10,148
            
            10,587
            
            8,898
            
            8,753
            
            8,152Balance
      Sheet Data:Assets
            $
            1,318,525
            $
            1,238,189
            $
            868,988
            $
            606,828
            $
            431,212Loans
      (including loans held for sale)
            
            1,237,717
            
            1,142,693
            
            753,246
            
            530,196
            
            360,749Other
      Real Estate Owned
            
            -
            
            1,255
            
            2,111
            
            303
            
            485Fed
      Funds Sold
            
            4,220
            
            18,180
            
            33,200
            
            16,800
            
            21,400FRB/FHLB
      Stock
            
            2,905
            
            1,996
            
            3,099
            
            2,378
            
            1,145Deposits
            
            1,161,071
            
            1,081,501
            
            742,432
            
            534,767
            
            383,487FHLB
      advances
            
            -
            
            -
            
            30,000
            
            -
            
            -Junior
      Subordinated Debt
            
            34,023
            
            41,240
            
            28,868
            
            20,620
            
            12,372Stockholders'
      equity
            
            107,959
            
            103,263
            
            58,181
            
            42,903
            
            29,683ALLL
      beginning balance
            $
            12,522
            $
            9,039
            $
            6,362
            $
            3,608
            $
            3,017Charge
      offs
            
            (1,336)
            
            (381)
            
            (540)
            
            (1,097)
            
            (505)Recoveries
            
            236
            
            214
            
            320
            
            30
            
            74Provision
      for loan losses
            
            4,600
            
            3,650
            
            2,897
            
            3,821
            
            1,022ALLL
      ending balance
            $
            16,022
            $
            12,522
            $
            9,039
            $
            6,362
            $
            3,608Non-performing
      loans
            $
            30,936
            $
            19,124
            $
            7,951
            $
            11,799
            $
            6,765Government
      guaranteed portion
            
            (10,379)
            
            (10,335)
            
            (6,514)
            
            (8,140)
            
            (5,269)Net
      non-performing loans
            $
            20,557
            $
            8,789
            $
            1,437
            $
            3,659
            $
            1,496SBA
      7A participation sold - period end
            $
            436,998
            $
            476,512
            $
            486,710
            $
            421,529
            $
            287,346Other
      participations sold
            
            10,325
            
            3,550
            
            16,489
            
            18,772
            
            18,906Total
      participation sold - period end
            $
            447,323
            $
            480,062
            $
            503,199
            $
            440,301
            $
            306,252




33


TEMECULA
      VALLEY BANCORP INC.Selected
      Financial DataFor
      the Year Ended December 31,2007
            2006
            2005
            2004
            2003Selected
      Ratios:
            (dollars
      and shares in thousands)Return
      on average assets
            
            1.16%
            
            1.64%
            
            1.91%
            
            2.00%
            
            2.04%Return
      on average equity
            
            14.18%
            
            23.89%
            
            27.71%
            
            28.94%
            
            31.84%Income
      tax rate
            
            40.67%
            
            40.80%
            
            41.47%
            
            41.60%
            
            40.90%Tier
      I leverage ratio
            
            10.63%
            
            11.42%
            
            9.28%
            
            9.20%
            
            9.06%Tier
      I risk based ratio
            
            9.65%
            
            10.49%
            
            8.93%
            
            9.68%
            
            10.01%Total
      risk based ratio
            
            10.80%
            
            11.90%
            
            11.02%
            
            11.81%
            
            11.54%Average
      Equity / Average Assets
            
            8.18%
            
            6.88%
            
            6.90%
            
            6.93%
            
            6.45%Allowance
      for loan loss/net loans and loans held-for-sale
            
            1.29%
            
            1.10%
            
            1.20%
            
            1.20%
            
            1.00%Allowance
      for loan loss/net loans excluding loans held-for-sale
            
            1.56%
            
            1.29%
            
            1.35%
            
            1.29%
            
            1.05%Allowance
      for loan loss/net nonperforming loans
            
            77.94%
            
            142.46%
            
            629.10%
            
            173.88%
            
            256.71%Loan
      to deposit ratio
            
            106.60%
            
            105.66%
            
            101.46%
            
            99.15%
            
            94.07%Average
      int earning assets/average total assets
            
            94.04%
            
            91.21%
            
            87.96%
            
            86.09%
            
            86.34%Investment
      yield
            
            5.18%
            
            5.03%
            
            3.30%
            
            1.37%
            
            1.07%Loan
      yield
            
            9.54%
            
            10.12%
            
            9.12%
            
            7.48%
            
            7.45%Total
      interest-bearing assets
            
            9.44%
            
            10.03%
            
            9.05%
            
            7.39%
            
            7.16%Interest-bearing
      deposit cost
            
            4.72%
            
            4.20%
            
            2.64%
            
            1.66%
            
            1.82%Borrowing
      cost
            
            7.56%
            
            7.41%
            
            5.64%
            
            4.06%
            
            4.32%Net
      interest margin
            
            5.36%
            
            6.37%
            
            6.78%
            
            5.98%
            
            5.69%Net
      interest spread
            
            4.61%
            
            5.68%
            
            6.24%
            
            5.59%
            
            5.25%Efficiency
      ratio
            
            63.28%
            
            59.31%
            
            60.31%
            
            60.76%
            
            67.06%SBA
      Loan Servicing:SBA
      excess servicing asset
            $
            5,350
            $
            8,288
            $
            8,169
            $
            7,586
            $
            6,117SBA
      I/O strip receivable asset
            
            6,599
            
            13,215
            
            22,068
            
            24,680
            
            20,496Total
      SBA servicing asset
            $
            11,949
            $
            21,503
            $
            30,237
            $
            32,266
            $
            26,613SBA
      servicing-fee income
            $
            7,137
            $
            9,077
            $
            10,265
            $
            8,738
            $
            6,026SBA
      servicing-asset fair value adjustment
            
            (11,180)
            
            -
            
            -
            
            -
            
            -SBA
      servicing-asset amortization
            
            -
            
            (11,487)
            
            (7,492)
            
            (6,120)
            
            (4,234)SBA
      servicing-guarantee fee to SBA
            
            (262)
            
            (205)
            
            (135)
            
            (118)
            
            (99)SBA
      servicing-net servicing income
            $
            (4,305)
            $
            (2,615)
            $
            2,638
            $
            2,500
            $
            1,693Loan
      Sales:SBA
      7A sales – guaranteed
            $
            89,820
            $
            114,589
            $
            108,912
            $
            146,881
            $
            129,813SBA
      7A guaranteed-sales gain
            
            4,299
            
            5,948
            
            5,113
            
            8,795
            
            8,149SBA
      7A sales – unguaranteed
            $
            13,543
            $
            20,556
            $
            37,011
            $
            35,365
            $
            19,209Unguaranteed
      SBA 7A sales gain
            
            1,510
            
            3,443
            
            6,510
            
            6,361
            
            3,191SBA
      Broker referral income
            $
            4,154
            $
            3,056
            $
            2,492
            $
            2,506
            $
            2,845Mortgage
      Broker referral income
            
            951
            
            1,258
            
            898
            
            963
            
            1,038Employee
      Related:Full
      time employees
            
            296
            
            299
            
            260
            
            229
            
            194Part
      time employees
            
            29
            
            18
            
            21
            
            16
            
            14Full
      time equivalent employees
            
            316
            
            312
            
            275
            
            238
            
            204Salary
      continuation plan expense
            $
            1,506
            $
            654
            $
            723
            $
            1,085
            $
            531CSV
      life insurance balance
            $
            28,034
            $
            24,036
            $
            17,591
            $
            9,594
            $
            5,741CSV
      Life insurance income
            $
            1,152
            $
            888
            $
            605
            $
            378
            $
            250CSV
      Life insurance expense
            
            (154)
            
            (143)
            
            (98)
            
            (61)
            
            (45)Net
      Life insurance income
            $
            998
            $
            745
            $
            507
            $
            317
            $
            205


34


The
following table sets forth our company’s unaudited results of operations for the
four quarters ended in 2007 and 2006. The only component of other comprehensive
income was in 2006 and is the adjustment to fair value, net of tax, of
interest-only strips, which are treated like investments in debt securities and
are classified as available-for-sale starting in 2007.





For
      the Quarter Ended in 2007March
      31,
            
            June
      30,
            
            September
      30,
            
            December
      31,Interest
      income
            $
            28,360
            $
            29,904
            $
            29,058
            $
            28,293Interest
      expense
            
            (12,110)
            
            (12,850)
            
            (12,541)
            
            (12,482)Net
      interest income
            
            16,250
            
            17,054
            
            16,517
            
            15,181Provision
      for loan losses
            
            (415)
            
            -
            
            (1,055)
            
            (3,130)Non-interest
      income
            
            3,938
            
            6,117
            
            1,520
            
            4,813Non-interest
      expense
            
            (12,664)
            
            (14,317)
            
            (12,641)
            
            (12,282)Income
      before income tax expense
            
            7,109
            
            8,854
            
            4,341
            
            5,212Income
      tax expense
            
            (2,930)
            
            (3,603)
            
            (1,746)
            
            (2,098)Net
      income
            $
            4,179
            $
            5,251
            $
            2,595
            $
            3,114Total
      comprehensive income
            $
            -
            $
            -
            $
            -
            $
            -Basic
      earnings per share
            $
            0.39
            $
            0.49
            $
            0.25
            $
            0.31Diluted
      earnings per share
            $
            0.38
            $
            0.47
            $
            0.25
            $
            0.30Dividends
      declared
            $
            N/A
            $
            0.04
            $
            0.04
            $
            0.04For
      the Quarter Ended in 2006March
      31,
            
            June
      30,
            
            September
      30,
            
            December
      31,Interest
      income
            $
            19,420
            $
            21,912
            $
            25,201
            $
            27,696Interest
      expense
            
            (6,052)
            
            (7,375)
            
            (9,608)
            
            (11,414)Net
      interest income
            
            13,368
            
            14,537
            
            15,593
            
            16,282Provision
      for loan losses
            
            (314)
            
            (1,096)
            
            (1,350)
            
            (890)Non-interest
      income
            
            4,941
            
            6,475
            
            4,333
            
            3,695Non-interest
      expense
            
            (11,077)
            
            (12,053)
            
            (11,604)
            
            (12,257)Income
      before income tax expense
            
            6,918
            
            7,863
            
            6,972
            
            6,830Income
      tax expense
            
            (2,937)
            
            (3,333)
            
            (2,954)
            
            (2,439)Net
      income
            $
            3,981
            $
            4,530
            $
            4,018
            $
            4,391Total
      comprehensive income
            $
            3,663
            $
            3,468
            $
            4,346
            $
            4,862Basic
      earnings per share
            $
            0.44
            $
            0.50
            $
            0.44
            $
            0.45Diluted
      earnings per share
            $
            0.42
            $
            0.47
            $
            0.41
            $
            0.43




35


ITEM
7:   MANAGEMENT
DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS









Management’s discussion, as well as
other provisions within this report, is intended to provide additional
information regarding the significant changes and trends in our Financial
Condition, Statements of Income, Funds Management, and Capital Planning.
Statements made in this report that state our intentions, beliefs, expectations
or predictions of the future are forward-looking statements. Our actual results
could differ materially from those projected in such forward-looking statements.
Additional information concerning factors that could cause actual results to
differ materially from those in the forward-looking statements is contained
elsewhere in this report and our other filings made with the SEC. Copies of such
filings may be obtained by contacting us or accessing our filings at www.sec.gov. We
intend the forward-looking statements to be covered by the safe harbor
provisions for forward-looking statements contained in the Private Securities
Litigation Reform Act of 1995, and we are including this statement for purposes
of invoking these safe harbor provisions. See "Cautionary Statement for Purposes
of the "Safe Harbor" Provision of the Private Securities Litigation Reform Act
of 1995," on the pages immediately following the table of contents in connection
with "forward looking" statements included in this report.





Results of
Operations





Net
Income





Our net income and basic and diluted
earnings per share for the years ended December 31, 2007, 2006, and 2005 are as
follows:





·
            For
      2007, net income was $15.1 million or $1.45 per basic share and $1.41 per
      diluted share.


·
            For
      2006, net income was $16.9 million or $1.83 per basic share and $1.73 per
      diluted share.


·
            For
      2005, net income was $14.0 million or $1.58 per basic share and $1.46 per
      diluted share.





We have
been profitable every full quarter since we opened in December 1996, except for
the first quarter of 1997. Our net interest margin for the last three years has
been consistently strong. This factor, coupled with gain on sale of loans and
servicing income associated with SBA and mortgage loan sales, represents a
significant portion of the profit dynamics of our company.





We sold
$89.8 million of the guaranteed portion and $13.5 million of the unguaranteed
portion of SBA 7(a) loans in 2007, which added $4.3 million and $1.5 million,
respectively, to revenue. We sold $114.6 million of the guaranteed portion and
$20.6 million of the unguaranteed portion of SBA 7(a) loans in 2006, which added
$5.9 million and $3.4 million, respectively, to revenue, and in 2005 we sold
$108.9 million of the guaranteed portion and $37.0 million of the unguaranteed
portion of SBA 7(a) loans, which added $5.1 million and $6.5 million,
respectively, to revenue. We expect to continue to sell SBA loans in the
secondary market.





Our
return on average assets and return on average equity for the years ended
December 31, 2007, 2006, and 2005 are as follows:





·
            For
      2007, return on average assets was 1.16%; return on average equity was
      14.18%.


·
            For
      2006, return on average assets was 1.64%; return on average equity was
      23.89%.


·
            For
      2005, return on average assets was 1.91%; return on average equity was
      27.71%.





Due
to increasing interest rates, mortgage loan activity slowed considerably in 2004
and remained at subdued levels in 2005 and 2006. In 2007, the housing slowdown
continued to decrease mortgage loan activity. During 2007, SBA 7(a) guaranteed
loan sales for 2007 were $89.8 million, compared to $114.6 million in 2006, and
$108.9 million in 2005.





Net
Interest Income





Net
interest income is the most significant component of our income from operations.
Net interest income is the difference between the interest and fees earned on
loans and investments (interest-earning assets) and the interest paid on
deposits and other borrowings (interest-bearing liabilities). Net interest
income depends on the volume of and interest rate earned on interest-earning
assets and the volume of and interest rate paid on interest-bearing
liabilities.


36


Net
interest income was $65.6 million in 2007, compared to $59.8 million in 2006,
and $43.5 million in 2005. The growth in net interest income levels have been
achieved as a result of strong asset mix, which consists primarily of loans at
variable rates, as well as growth of our loan portfolio. Our net interest margin
was 5.36% in 2007, compared to 6.37% in 2006, and 6.78% in 2005. In the initial
cycle of a flat rate environment following a rising rate environment, the net
interest margin will slightly compress due to longer term, lower rate time
deposits maturing and repricing at a higher rate. In a flat rate environment
followed by a falling rate environment, the net interest margin will compress,
mostly in the first six months, due to assets repricing more frequently than
deposits. Although the yield on interest-earning assets decreased by 59 basis
points for 2007, the yield on interest-bearing liabilities increased by 48 basis
points for the same period. The following is a summation of various yields for
interest-earning assets and interest-bearing liabilities at December 31, 2007,
2006, and 2005:





·
            Loans
      produced a yield of 9.54% in 2007, 10.12% in 2006, and 9.12% in 2005. The
      decrease in loan yields has been the result of a decreasing interest rate
      environment and higher nonaccrual
loans.


·
            Yield
      on investments, Federal Funds Sold and U.S. Agencies, increased to 5.18%
      in 2007, compared to 5.03% in 2006, and 3.30% in 2005. The increase in
      investment yields is a result of an increase in average federal funds rate
      from 5.03% in 2006 to 5.12% in
2007.


·
            Total
      interest-earning assets yielded 9.44% in 2007, 10.03% in 2006, and 9.05%
      in 2005.


·
            Cost
      of interest-bearing deposits increased to 4.72% in 2007, compared to 4.20%
      in 2006, and 2.64% in 2005. The increase is a result of the growth in
      higher rate interest-bearing deposits compared to the other
      interest-bearing deposits.


·
            Cost
      of other borrowings, FHLB advances, and junior subordinated debt
      borrowings, increased to 7.56% in 2007, compared to 7.41% in 2006 and
      5.64% in 2005. Contributing to the increase in the cost of borrowings was
      the slight increase in junior subordinated debt
  rates.





Our goal
is to maintain at least 90% of our assets as interest-earning assets. For 2007,
our average interest-earning assets to total average assets were
­­­­­94.04%, compared to ­­­­­91.21% for
2006, and 87.96% for 2005. This ratio for 2005 was below our target due to the
SBA servicing asset, the related SBA interest-only strip receivable, and the
cash surrender value of life insurance (“BOLI”), our largest components of non
interest-earning assets.





The following table shows average
balances with corresponding interest income and interest expense as well as
average yield and cost information for the last three years. Average balances
are derived from daily balances, and nonaccrual loans are included as
interest-bearing loans for the purposes of these tables.


37





Average
      Balances with Rates Earned and PaidYear
      ended December 31,2007
            
            
            
            
            
            2006
            
            
            
            
            
            2005Interest
            Average
            
            
            
            
            Interest
            Average
            
            
            
            
            Interest
            AverageAverage
            
            Income/
            Interest
            
            
            Average
            
            Income/
            Interest
            
            
            Average
            
            Income/
            InterestBalance
            
            Expense
            Rate
            
            
            Balance
            
            Expense
            Rate
            
            
            Balance
            
            Expense
            RateAssets
            
            (
      dollars in thousands)Interest-bearing
      deposits
            
            $
            593
            $
            31
            5.23%
            
            $
            54
            $
            3
            5.56%
            
            $
            -
            $
            -
            0.00%Securities-HTM (1)
            
            
            2,105
            
            124
            5.89%
            
            
            381
            
            19
            4.99%
            
            
            203
            
            6
            2.96%Federal
      Funds Sold
            
            
            24,815
            
            1,270
            5.12%
            
            
            16,497
            
            829
            5.03%
            
            
            7,224
            
            239
            3.29%Total
      Investments
            
            
            27,513
            
            1,425
            5.18%
            
            
            16,932
            
            851
            5.03%
            
            
            7,427
            
            245
            3.30%Total
      Loans (2)
            
            
            1,196,849
            
            114,190
            9.54%
            
            
            922,264
            
            93,378
            10.12%
            
            
            634,731
            
            57,880
            9.12%Total
      Interest Earning Assets
            
            1,224,362
            
            115,615
            9.44%
            
            
            939,196
            
            94,229
            10.03%
            
            
            642,158
            
            58,125
            9.05%Allowance
      for Loan Loss
            
            
            (12,848)
            
            
            
            
            
            (10,311)
            
            
            
            
            
            (7,606)Cash
      & Due From Banks
            
            
            12,527
            
            
            
            
            
            24,286
            
            
            
            
            
            25,385Premises
      & Equipment
            
            
            5,413
            
            
            
            
            
            5,173
            
            
            
            
            
            4,673Other
      Assets
            
            
            72,478
            
            
            
            
            
            71,310
            
            
            
            
            
            65,414Total
      Assets
            
            $
            1,301,932
            
            
            
            
            $
            1,029,654
            
            
            
            
            $
            730,024Liabilities
      andShareholders'
      EquityInterest
      Bearing Demand
            
            $
            31,543
            
            47
            0.15%
            
            $
            31,161
            
            47
            0.15%
            
            $
            32,791
            
            49
            0.15%Money
      Market
            
            
            119,922
            
            4,445
            3.71%
            
            
            83,672
            
            2,727
            3.26%
            
            
            50,239
            
            912
            1.81%Savings
            
            
            29,460
            
            127
            0.43%
            
            
            31,685
            
            122
            0.39%
            
            
            38,010
            
            141
            0.37%Time
      Deposits under $100,000
            
            404,244
            
            20,579
            5.09%
            
            
            293,909
            
            13,876
            4.72%
            
            
            175,124
            
            5,555
            3.17%Time
      Deposits $100,000 or more
            
            410,680
            
            21,794
            5.31%
            
            
            315,346
            
            14,942
            4.74%
            
            
            194,496
            
            6,293
            3.24%Other
      Borrowings
            
            
            39,560
            
            2,991
            7.56%
            
            
            36,906
            
            2,735
            7.41%
            
            
            28,993
            
            1,634
            5.64%Total
      Interest Bearing Liabilities
            
            1,035,409
            
            49,983
            4.83%
            
            
            792,679
            
            34,449
            4.35%
            
            
            519,653
            
            14,584
            2.81%Non-interest
      Demand Deposits
            
            144,317
            
            
            
            
            
            154,473
            
            
            
            
            
            151,447Other
      Liabilities
            
            
            15,704
            
            
            
            
            
            11,683
            
            
            
            
            
            8,569Shareholders'
      Equity
            
            
            106,502
            
            
            
            
            
            70,819
            
            
            
            
            
            50,355Total
      Liabilities andShareholders'
      equity
            
            $
            1,301,932
            
            
            
            
            $
            1,029,654
            
            
            
            
            $
            730,024Net
      Interest Income
            
            
            
            $
            65,632
            
            
            
            
            $
            59,780
            
            
            
            
            $
            43,541Interest
      Spread (3)
            
            
            
            
            
            4.61%
            
            
            
            
            
            5.68%
            
            
            
            
            
            6.24%Net
      Interest Margin (4)
            
            
            
            
            5.36%
            
            
            
            
            
            6.37%
            
            
            
            
            
            6.78%(1)   There
      are no tax exempt investments in any of the reported
years.(2)   Average
      balances are net of deferred fees/costs that are amortized to interest
      income over the term of the respective loan.(3)   Net
      interest spread is the yield earned on interest earning assets less the
      rate paid on interest bearing liabilities.(4)   Net
      interest margin is the net interest income divided by the interest earning
      assets.




38


The
following table shows a comparison of interest income and interest expense as
the result of changes in the volumes and rates on average interest-earning
assets and average interest-bearing liabilities for the years
indicated.





Rate/Volume
      AnalysisIncrease/Decrease
      in Net Interest IncomeYear
      Ended December 312007
            
            
            
            
            
            
            2006Assets
            
            
            Volume
            
            Rate
            
            Total
            
            
            Volume
            
            Rate
            
            Total(dollars
      in thousands)Due
      From Banks-Time
            $
            27
            $
            1
            $
            28
            
            $
            -
            $
            3
            $
            3Securities-HTM (1)
            
            86
            
            19
            
            105
            
            
            5
            
            8
            
            13Federal
      Funds Sold
            
            418
            
            23
            
            441
            
            
            306
            
            284
            
            590Total
      Investments
            
            531
            
            43
            
            574
            
            
            311
            
            295
            
            606Total
      Loans (2)
            
            28,071
            
            (7,259)
            
            20,812
            
            
            26,925
            
            8,573
            
            35,498Total
      Interest Earning Assets
            $
            28,602
            $
            (7,216)
            $
            21,386
            
            $
            27,236
            $
            8,868
            $
            36,104Liabilities
      and Shareholders' EquityInterest
      Bearing Demand
            
            1
            
            (1)
            
            -
            
            
            (2)
            
            (1)
            
            (3)Money
      Market
            
            1,181
            
            537
            
            1,718
            
            
            607
            
            1,209
            
            1,816Savings
            
            
            (9)
            
            14
            
            5
            
            
            (24)
            
            4
            
            (20)Time
      Deposits under $100,000
            
            5,209
            
            1,494
            
            6,703
            
            
            3,768
            
            4,554
            
            8,322Time
      Deposits $100,000 or more
            
            4,517
            
            2,335
            
            6,852
            
            
            3,909
            
            4,740
            
            8,649Other
      Borrowings
            
            276
            
            (20)
            
            256
            
            
            555
            
            546
            
            1,101Total
      Interest Bearing Liabilities
            
            11,175
            
            4,359
            
            15,534
            
            
            8,813
            
            11,052
            
            19,865Net
      Interest Income
            $
            17,427
            $
            (11,575)
            $
            5,852
            
            $
            18,423
            $
            (2,184)
            $
            16,239(1)   There
      are no tax exempt investments in any of the reported
years.(2)   Average
      balances are net of deferred fees/gains that are amortized to interest
      income over the term of the respective
loan.







Provision
for Loan Loss





The
allowance for loan losses represents our management’s best estimate of probable
losses in our loan portfolio. We have a monitoring system to identify impaired
and/or potential problem loans. This system assists in the periodic evaluation
of impairment and determining the amount of the allowance for loan losses
required.





Our
monitoring system and allowance for loan losses methodology has evolved over a
period of years, and loan classifications have been incorporated into the
determination of our allowance for loan losses. Our monitoring system and
allowance methodology include an assessment of individual classified loans, as
well as applying loss factors to all loans not individually classified.
Classified loans are reviewed individually to estimate the amount of probable
loss that needs to be included in our allowance. These reviews include analysis
of financial information as well as evaluation of collateral securing the
credit. The analysis considers general factors such as changes in lending
policies and procedures, economic trends, loan volume trends, changes in lending
management and staff, trends in delinquencies, nonaccruals and charge-offs,
changes in loan review and Board oversight, the effects of competition, legal
and regulatory requirements, and factors inherent to each loan
pool.





The
provision was $4.6 million in 2007, $3.7 million in 2006, and $2.9 million in
2005. The allowance, as a percentage of net loans outstanding, including loans
held-for-sale, was 1.29% as of December 31, 2007, 1.10% as of December 31, 2006,
and 1.20% as of December 31, 2005. The allowance, as a percentage of net loans
outstanding, excluding loans held-for-sale, was 1.56% as of December 31, 2007,
1.29% as of December 31, 2006, and 1.35% as of December 31, 2005. We plan to
continue to sell the unguaranteed portion of SBA 7(a) loans to mitigate the risk
associated with SBA 7(a) loans.





We had
$30.9 million of nonperforming loans as of December 31, 2007, of which $10.4
million was guaranteed by the SBA, compared to $19.1 million of nonperforming
loans as of December 31, 2006, of which $10.3 million was guaranteed by the SBA,
and $8.0 million of nonperforming loans as of December 31, 2005, of which $6.5
million was SBA guaranteed. The majority of nonperforming assets are SBA loans,
which represent $14.1 million of the net exposure. The remaining $6.4 million of
conventional non-accrual loans consists of five loans. Of the two most
significant of these loans, one is a $3.1 million construction loan for 25
single family residences located in Victorville, CA. Ten homes have sold and
closed escrow


39


and there
are five homes in escrow. The remaining 10 homes are completed and unsold. We
feel that there is approximately $470,000 in loss exposure on the Victorville
project. The other is a land development loan for $2.2 million located in
Folsom, CA, where we do not anticipate a loss. The allowance for loan losses was
$16.0 million at December 31, 2007, compared to $12.5 million at December 31,
2006, and $9.0 million at December 31, 2005. Net charge-offs were $1.1 million
in 2007, $167 thousand in 2006, and $220 thousand in 2005.





Non-Interest
Income





Non-interest
income is an important revenue source for us. Non-interest income consists of
service charges and fees, gain on sale of loans and other assets, and loan
servicing, broker and other loan related income. Non-interest income was $16.4
in 2007, compared to $19.4 million in 2006, and $23.8 million in 2005. The
primary contributor to the decrease in non-interest income from 2005 to 2007 was
the decrease in the SBA servicing income. Servicing income was affected by
higher prepayment rates in the first half of 2007 and by higher discount rates
in the second half of 2007. The following table summarizes the components of
non-interest income as of December 31, 2007, 2006, and 2005.





Analysis
      of Changes in Non-Interest IncomeIncrease/Decrease
            
            
            
            
            Increase/Decrease2007
            
            
            Amount
            %
            
            
            2006
            
            
            Amount
            %
            
            
            2005(dollars
      in thousands)Service
      charges and fees
            $
            604
            
            $
            (14)
            (2%)
            
            $
            618
            
            $
            14
            2%
            
            $
            604Gain
      on loan sales
            
            10,124
            
            
            (3,041)
            (23%)
            
            
            13,165
            
            
            (226)
            (2%)
            
            
            13,391Servicing
      income
            
            (4,305)
            
            
            (1,690)
            65%
            
            
            (2,615)
            
            
            (5,253)
            (199%)
            
            
            2,638Loan
      broker income
            
            5,104
            
            
            790
            18%
            
            
            4,314
            
            
            923
            27%
            
            
            3,391Loan
      Related Income
            
            2,720
            
            
            504
            23%
            
            
            2,216
            
            
            (176)
            (7%)
            
            
            2,392Other
      income
            
            2,141
            
            
            395
            23%
            
            
            1,746
            
            
            340
            24%
            
            
            1,406Total
            $
            16,388
            
            $
            (3,056)
            (16%)
            
            $
            19,444
            
            $
            (4,378)
            (18%)
            
            $
            23,822





The
following table summarizes the gain on sale of loans and other assets as of
December 31, 2007, 2006, and 2005.





Gain
      on Sale of Loans / Assets2007
            
            2006
            
            2005(dollars
      in thousands)SBA
      7A Unguaranteed Sales
            $
            1,510
            
            $
            3,443
            
            $
            6,510SBA
      7A Guaranteed Sales
            
            4,294
            
            
            5,948
            
            
            5,1131st
      Trust Deed Sales
            
            2,064
            
            
            -
            
            
            -SBA
      504 Sales
            
            905
            
            
            1,278
            
            
            290Mortgage
      Sales
            
            -
            
            
            -
            
            
            285Other
      Loan Related
            
            1,351
            
            
            2,496
            
            
            1,192REO
      Gain (Loss)
            
            (9)
            
            
            75
            
            
            (26)Fixed
      Assets
            
            (16)
            
            
            (8)
            
            
            5Total
            $
            10,099
            
            $
            13,232
            
            $
            13,369





The
SBA servicing loss was $4.3 million in 2007 and $2.6 million in 2006. SBA
servicing income was $2.6 million in 2005. The following table summarizes
components of the SBA servicing income as of December 31, 2007, 2006, and
2005.


SBA
      Servicing Income2007
            
            2006
            
            2005(dollars
      in thousands)SBA
      Servicing Income
            $
            7,137
            
            $
            9,077
            
            $
            10,265SBA
      Servicing Guarantee Fee
            
            (262)
            
            
            (205)
            
            
            (134)SBA
      Servicing Excess Amortization
            
            -
            
            
            (11,487)
            
            
            (7,493)SBA
      Servicing Fair Value
            
            (11,180)
            
            
            -
            
            
            -Total
            $
            (4,305)
            
            $
            (2,615)
            
            $
            2,638





Most SBA
7(a) guaranteed loans sold in the secondary market currently garner a cash
premium over par, whereas par loan sales carry a higher servicing rate and
provide higher values for interest only strips. As a result of our focus on cash
premiums, the weighted-average rate on the servicing assets have been
decreasing. At December 31, 2007, we were


40


servicing
approximately $374.4 million of the guaranteed portion of 7(a) loans previously
sold in the secondary market with a weighted-average servicing and I/O rate of
1.69%. At December 31, 2006, we were servicing approximately $399.9 million of
the guaranteed portion of 7(a) loans previously sold in the secondary market
with a weighted-average servicing and I/O rate of 2.01%. The decrease in
servicing income has resulted from the declining fair value of the servicing and
I/O assets to account for an increase in the prepayments experienced in our SBA
loan portfolio, as well as a decrease in ongoing servicing income resulting from
the lower servicing rate.





Non-Interest
Expense





Non-interest
expenses consist of salaries and benefits, occupancy, furniture and equipment,
processing, office expense and professional costs such as legal and auditing,
marketing and regulatory fees. These expenses are reviewed and controlled to
maintain cost effective levels of operation. Non-interest expense was $51.9
million in 2007, compared to $47.0 million in 2006, and $40.6 million in 2005.
Non-interest expense is expected to continue to increase as the size of our
company increases. The following table summarizes the non-interest expense as of
December 31, 2007, 2006, and 2005:





Analysis
      of Changes in Non-Interest ExpenseIncrease/Decrease
            
            
            
            
            Increase/Decrease2007
            
            
            Amount
            %
            
            
            2006
            
            
            Amount
            %
            
            
            2005(dollars
      in thousands)Salaries
      and employee benefits
            $
            33,557
            
            $
            1,568
            5%
            
            $
            31,989
            
            $
            5,018
            19%
            
            $
            26,971Occupancy
      of premises
            
            3,219
            
            
            184
            6%
            
            
            3,035
            
            
            607
            25%
            
            
            2,428Furniture
      and equipment
            
            1,929
            
            
            210
            12%
            
            
            1,719
            
            
            207
            14%
            
            
            1,512Data
      processing
            
            1,381
            
            
            116
            9%
            
            
            1,265
            
            
            138
            12%
            
            
            1,127Marketing
      and Business Promotion
            
            1,176
            
            
            205
            21%
            
            
            971
            
            
            (151)
            (13%)
            
            
            1,122Legal
      and Professional
            
            1,387
            
            
            244
            21%
            
            
            1,143
            
            
            88
            8%
            
            
            1,055Regulatory
      Assessments
            
            765
            
            
            580
            314%
            
            
            185
            
            
            (61)
            (25%)
            
            
            246Travel
      & Entertainment
            
            1,075
            
            
            (50)
            (4%)
            
            
            1,125
            
            
            177
            19%
            
            
            948Loan
      Related Expense
            
            3,141
            
            
            774
            33%
            
            
            2,367
            
            
            229
            11%
            
            
            2,138Office
      Expenses
            
            2,640
            
            
            44
            2%
            
            
            2,596
            
            
            (81)
            (3%)
            
            
            2,677Other
      Expenses
            
            1,635
            
            
            1,039
            174%
            
            
            596
            
            
            193
            48%
            
            
            403Total
            $
            51,905
            
            $
            4,914
            10%
            
            $
            46,991
            
            $
            6,364
            16%
            
            $
            40,627





Salaries and benefits were $33.6
million in 2007, compared to $32.0 million in 2006, and $27.0 million in 2005.
The increase in salaries and benefits is a result of the expansion of the Risk
Management, Information Technology, and Appraisal Departments as well as the
addition of the Solana Beach, Ontario, and San Marcos branches, the Inland
Empire loan production unit, and the SBA unguaranteed purchase program, and
growth of the SBA wholesale lending unit. Included in the salaries and benefits
expense in 2007 and 2006 is $806 thousand and $1.1 million for stock-based
compensation for all share-based payments vested in 2007 as a result of the
adoption of SFAS No. 123R.





Occupancy expense was $3.2 million in
2007, compared to $3.0 million in 2006, and $2.4 million in 2005. Furniture and
equipment expense was $1.9 million in 2007, compared to $1.7 million in 2006,
and $1.5 million in 2005. Contributing to these increases are the costs related
to the opening of the San Marcos branch in 2007, the Solana Beach and Ontario
branches in 2006, and the Carlsbad branch in 2005.





Legal and professional expenses were
$1.4 million in 2007 and $1.1 million in 2006 and 2005. The increase in legal
and professional expenses from 2005 to 2007 is the result of increased external
and internal audit fees related to Sarbanes-Oxley compliance, and legal fees
associated with employment agreements, stock repurchases, and our employee stock
option program.





Regulatory assessments were $765
thousand in 2007, compared to $185 thousand in 2006, and $246 thousand in 2005.
In November 2006, the Federal Deposit Insurance Corporation ("FDIC")
finalized a rule intended to match an institution's deposit insurance
premium to the risk an institution poses to the deposit insurance fund.
The final regulations adopt a new base schedule of rates that the FDIC
Board could adjust up or down, depending on the revenue needs of the insurance
fund. During the third quarter of 2007, we were assessed at the new deposit
insurance rate retroactive to March 31, 2007. We anticipate regulatory
assessment expenses of approximately $200 thousand per quarter going forward at
the current deposit levels.





Loan funding expenses were $3.1 million
in 2007, compared to $2.4 million in 2006, and $2.1 million in 2005. The
increase in loan funding expense is a result of the continued growth in our loan
portfolio.


41


Income
Taxes





For 2007,
the tax expense was $10.4 million, for an effective rate of 40.7%, for 2006, the
tax expense was $11.7 million, for an effective rate of 40.8%, and for 2005 the
tax expense was $9.9 million, for an effective rate of 41.5%. The decrease in
the effective rate for 2006 was largely due to larger enterprise zone deductions
in 2006 than in 2005. Deferred tax assets totaled $10.1 million at December 31,
2007, $8.5 million at December 31, 2006, and $5.7 million at December 31, 2005.
Over half of the deferred tax asset is due to the tax deductibility timing
difference of the provision for loan losses.





Financial
Condition





General




As of December 31, 2007, total assets
increased 6.49% to $1.32 billion, compared to $1.24 billion as of December 31,
2006. Total gross loans increased to $1.24 billion as of December 31, 2007, or
8.15%, compared to $1.15 billion as of December 31, 2006. Deposits grew 7.36% to
$1.16 billion as of December 31, 2007, compared to $1.08 billion as of December
31, 2006.




Assets




Total
assets were $1.32 billion at December 31, 2007, compared to $1.24 billion at
December 31, 2006, a 6.49% increase. The increase was due to a $4.0 million
increase in cash surrender value of life insurance, and an increase in gross
loans, including loans held-for-sale, outstanding of $93.4 million. Asset growth
is expected to continue due to the expansion of our branches, growth of the SBA
wholesale lending unit, and growth of the Inland Empire loan production
unit.





Total
loans and loans held-for-sale, excluding deferred loan fees and allowance for
loan loss, were $1.24 billion at December 31, 2007, compared to $1.15 billion at
December 31, 2006, an 8.15% increase. Much of the increase is due to increases
in construction loans and SBA loans. Our loan portfolio composition is primarily
construction, commercial, SBA, and real estate secured loans. SBA 7(a) loans, of
which we are an active originator, consisting of both commercial and real estate
loans, comprise approximately 23% of loans outstanding at December 31, 2007 and
2006, and 13% as of December 31, 2005. Approximately 92% of the loan portfolio
is in real estate secured loans as of December 31, 2007, compared to 94% and 95%
for comparable periods in 2006 and 2005, respectively.





At
December 31, 2007, approximately 6% of the loans were commercial loans, compared
to approximately 5% at December 31, 2006. Even though there is softness in the
residential loan market, the rate of loan growth for our bank is projected to be
strong due to the addition of the Inland Empire loan production unit, the
wholesale SBA program, and growth of our branch system.





The
allowance for loan losses was $16.0 million at December 31, 2007, compared to
$12.5 million at December 31, 2006. Net charge-offs were $1.1 million in 2007
and $167 thousand in 2006. The provision for loan losses was $4.6 million in
2007 and $3.7 million in 2006. The allowance, as a percentage of net loans
outstanding, including loans held-for-sale, was 1.29% and 1.10% at December 31,
2007 and 2006, respectively. The allowance, as a percentage of net loans
outstanding, excluding loans held-for-sale, was 1.56% and 1.29% at December 31,
2007 and 2006, respectively.





Federal
Funds Sold were $4.2 million at December 31, 2007, compared to $18.2 million at
December 31, 2006. The change from 2006 to 2007 is largely attributable net
loans outstanding increasing $60.6 million more than deposits, and the increase
in capital.





At
December 31, 2007, the SBA servicing asset was $5.4 million, the SBA I/O strip
receivable was $6.6 million, and the cash surrender value of life insurance was
$28.0 million. At December 31, 2006, the SBA servicing asset was $8.3 million,
the SBA I/O strip receivable was $13.2 million, and the cash surrender value of
life insurance was $24.0 million.





Loan
Portfolio




Moderate
loan demand in 2007 resulted in a 15.3% increase in commercial loans, a 4.2%
increase in construction lending, a 6.9% decrease in real estate lending, and a
23.8% increase in SBA loans. We originated brokered loans, totaling $71.1
million in 2007, compared with $96.7 million in 2006, and $63.7 million in 2005.
Sales of mortgage loans totaled $13.7 million in 2005. There were no sales of
mortgage loans in 2006 and 2007. The servicing portfolio, which consists of SBA
loans sold to other investors, was $447.3 million as of December 31, 2007,
compared to $480.0 million as of December 31, 2006, and $503.2 million as
of December 31, 2005.


42


The
majority of our loans have floating rates tied to Wall Street Journal or other
market rate indicators. This serves to lessen the risk from movement in interest
rates, particularly rate increases.




Nonperforming
Assets





Nonperforming assets consist of
nonaccrual loans, loans 90 or more days past due and still accruing interest,
and Other Real Estate Owned (“OREO”). We had $30.9 million of nonperforming
assets as of December 31 2007, of which $10.4 million was guaranteed by the SBA,
compared to $20.4 million of nonperforming assets as of December 31 2006, of
which $11.0 million was guaranteed by the SBA, and $10.1 million of
nonperforming assets as of December 31, 2005, of which $7.1 million was
government guaranteed. The majority of nonperforming assets are SBA loans, which
represent $14.1 million of the net exposure. The remaining $6.4 million of
conventional non-accrual loans consists of five loans. One is a $3.1 million
construction loan for 25 single family residences located in Victorville, CA.
Ten homes have sold and closed escrow and there are five homes in escrow. The
remaining 10 homes are completed and unsold. We feel that there is approximately
$470,000 in loss exposure on the Victorville project. The other is a land
development loan for $2.2 million located in Folsom, CA, where we do not
anticipate a loss. There was $1.3 million of OREO at December 31, 2006, of which
$638 thousand was guaranteed by the SBA, compared to $2.1 million of OREO at
December 31, 2005, of which $604 thousand was guaranteed by the SBA. There was
no OREO at December 31, 2007.





Nonaccrual
Loans





Nonaccrual loans, net of the government
guaranteed portion, were $20.6 million or 1.66 % of total gross loans as of
December 31, 2007, compared to $8.8 million or 0.77 % of total gross loans as of
December 31, 2006, and $1.4 million or 0.19% of total gross loans as of December
31, 2005.





Classified
Assets





From time to time, our management has
reason to believe that certain borrowers may not be able to repay their loans
within the parameters of the present repayment terms, even though, in some
cases, the loans are current at the time. These loans are graded in the
classified loan grades of “substandard” or “doubtful” or “loss” and include most
nonperforming loans. Each classified loan is monitored at least monthly and more
frequently, as necessary. Classified assets, net of government guarantees,
(loans graded as substandard or lower and OREO) at December 31, 2007, 2006, and
2005 were $44.2 million, $19.5 million, and $5.0 million,
respectively.




Risk
Management





The investment of our funds is
primarily in loans, where a greater degree of risk is normally assumed, than in
other forms of investments. Sound underwriting of loans and continuing
evaluations of the underlying collateral and performance of our borrowers are an
integral part in the maintenance of a high level of quality in our total assets.
Net loan charge-offs for the year ended December 31, 2007 were $1.1 million, or
0.09% of average gross loans outstanding, compared to $167 thousand, or 0.02% of
average gross loans outstanding for the year ended December 31, 2006, and $220
thousand, or 0.03% of average gross loans outstanding, for the year ended
December 31, 2005.





Allowance
for Loan Losses





As of December 31, 2007, the balance in
the allowance for loan losses was $16.0 million, compared to $12.5 million as of
December 31, 2006, and $9.0 million as of December 31, 2005. Risks and
uncertainties exist in all lending transactions and even though there have
historically been very few charge offs in any category of our loans, loss
allocations have been established for each loan category. These allocations are
based upon loan type and loan classification, as well as market conditions for
the underlying real estate and other collateral, trends in the real estate
market, economic uncertainties, and other risks where it is probable that losses
may be incurred. In general, there are no loss allocations established for the
government guaranteed portion of loans. The allowance for loan losses was 1.29%
of total net loans and loans held-for-sale as of December 31, 2007, 1.10% as of
December 31, 2006, and 1.20% as of December 31, 2005. The allowance for loan
losses was 1.56% of total net loans excluding loans held-for-sale as of December
31, 2007, 1.29% as of December 31, 2006, and


43


1.35% as
of December 31, 2005. The allowance for loan losses as a percentage of gross
nonaccrual loans was 51.79% as of December 31, 2007, compared to 65.48% as of
December 31, 2006, and 113.69% as of December 31, 2005. The allowance for loan
losses to nonperforming loans, net of government guarantees was 77.94% as of
December 31, 2007, compared to 142.46% as of December 31, 2006, and 629.10% as
of December 31, 2005.





The provision for loan losses charged
to operations reflects management's judgment of the allowance for loan losses
and is determined through quarterly analytical reviews of the loan portfolio,
problem loans, and consideration of such other factors as our bank's loan loss
experience, trends in problem loans, concentrations of credit risk, and current
economic conditions, as well as the results of our bank's ongoing credit
examination process and that of our regulators. As conditions change, our level
of provision for loan loss and allowance for loan losses may
change.





During the year ended December 31,
2007, we charged off $1.1 million (net of recoveries) and provided $4.6 million
to the provision for loan losses. During the year ended December 31, 2006, we
charged off $167 thousand (net of recoveries) to the allowance while providing
$3.7 million to the provision for loan losses. During the year ended December
31, 2005, we charged off $220 thousand (net of recoveries) and provided $2.9
million to the provision for loan losses. Although we believe that we use the
best information available to make determinations of the allowance for loan
losses, future adjustments to the allowance for loan losses may be necessary and
results of operations could be significantly and adversely affected if
circumstances differ substantially from the assumptions used in making the
determinations.





During
2005, 2006, and 2007, net charge offs as a percentage of average loans
outstanding were only 0.03%, 0.02%, and 0.09%, respectively. We have established
loss allocations for each homogeneous category based upon loan type, as well as
specific allocations for special mention and classified loans. Certain loan
types may not have incurred charge-offs or have historically had minimal losses,
but it is probable that losses may be incurred. We consider trends in
delinquencies, potential charge offs by loan type, market for underlying real
estate or other collateral, trends in industry types, economic changes and other
risks.





Accounting
for the Allowance for Loan Losses





Non-homogenous
exposures, representing individual credit exposures, are evaluated based upon
the borrower's overall financial condition, resources, and payment record; the
prospects for support from any financially responsible guarantors; and, if
appropriate, the realizable value of any collateral. The allowance for loan
losses attributed to these loans is established via a process that begins with
estimates of probable losses in the portfolio based upon the present value of
the expected future cash flows discounted in the loan's contractual effective
rate, the secondary market value of the loan and the discounted fair value of
collateral. This analysis includes all special mention, substandard, doubtful,
and loss rated loans. The credit administration review and expertise in
analyzing and working out these loans is critical to the accuracy of this
process.





Each
portfolio of homogeneous loans is collectively evaluated for loss potential. The
allowance for loan losses is established via a process that begins with
estimates of probable incurred losses in the portfolio, based upon various
statistical analyses. These include historical credit loss experience, together
with analyses that reflect current trends and conditions. The analysis considers
general factors such as changes in lending policies and procedures, economic
trends, loan volume trends, changes in lending management and staff, trends in
delinquencies, nonaccruals and charge-offs, changes in loan review and Board
oversight, the effects of competition, legal and regulatory requirements, and
factors inherent to each loan pool.





Life
Insurance -Cash Surrender Value





The
cash surrender value of life insurance is bank owned life insurance (“BOLI”).
The BOLI death benefit provides key man insurance for our bank, as well as
providing coverage for the future payments, of the executive Salary Continuation
Plan (“SCP”). As of December 31, 2007, there are 15 current and previously
employed executives covered by BOLI. The BOLI had a balance of $28.0 million at
December 31, 2007, compared to $24.0 million at December 31, 2006, and $17.6
million at December 31, 2005. The total death benefit at December 31, 2007 was
approximately $57.2 million. The BOLI earnings in 2007, net of mortality cost,
were $998 thousand, compared to $745 thousand in 2006, and $507 thousand in
2005. The net earnings of BOLI are tax-free. The SCP expense before tax in 2007
was $1.5 million, compared to $654 thousand in 2006, and $723 thousand in 2005.
See the notes in the financial statements for additional
information.





Servicing
Asset and Interest-Only Strips Receivable





Servicing assets are recognized when
loans are sold with servicing retained. Servicing assets are measured at fair
value and changes in fair value are recorded in earnings in the period which the
change occurs. The fair value of servicing assets is estimated by discounting
the future cash flows at estimated future current market rates for the expected
life of the loans. We use industry prepayment statistics in estimating the
expected life of the loan.


44


SBA 7(a)
loans can be sold for a premium or for par. When an SBA 7(a) loan is sold for a
premium, the originator is required to retain at least 1% interest on the sold
portion of the loan. The 1% interest is considered the contractual servicing fee
for the loan. When an SBA 7(a) loan is sold for par, the originator generally
retains a much larger interest than the required contractual servicing. The
premium represents what the buyer is willing to pay the originator for the
difference between the rates passed through to the buyer in a premium sale
versus a par sale. When we feel that the premium is not sufficient to compensate
us for the future income resulting from the higher retained interest in a par
sale, we will sell the loan at par versus a premium.





The
servicing assets represent the value of the contractual servicing fee less costs
to service in the SBA industry have been considered 40 basis points. Therefore,
the servicing asset value is based upon the contractual servicing fee of
generally 1%, less servicing costs of 40 basis points. When the interest rate
retained exceeds the contractual servicing fee, generally 1% for SBA 7(a) loans,
the excess over 1% is considered the I/O. At December 31, 2007, 2006, and 2005,
we had I/O strips of $6.6 million, $13.2 million, and $22.1 million
respectively, which approximate fair value. Fair value is estimated by
discounting estimated future cash flows from the I/O strips using assumptions
similar to those used in valuing servicing assets. In addition, we obtain a
third party valuation on a quarterly basis.





The net
servicing asset decreased to $5.4 million as of December 31, 2007, compared to
$8.3 million as of December 31, 2006, and $8.2 million as of December 31, 2005.
The decrease reflects the decline in serviced assets from $399.9 million at
December 31, 2006 to $374.4 million at December 31, 2007, the increase in
discount rates used to value the servicing assets, and an increase in the
prepayment assumptions. The valuation of the servicing asset reflects estimates
of the expected life of the underlying loans, which may be adversely affected by
higher than expected levels of pay-offs in periods of lower rates or charge-offs
in periods of economic difficulty. In addition, when property values increase
due to general economic conditions, borrowers have refinancing opportunities
available to them which may result in higher prepayment rates. See the footnotes
to the financial statements, found elsewhere in this Annual Report, for further
information on servicing assets.





Investments/Financial
Assets





Federal Home Loan Bank (“FHLB”) stock
and FNMA mortgage-backed security, was $5.9 million at December 31, 2007
and $3.0 million at December 31, 2006. Federal Reserve Bank and FHLB stock,
which are not included in the investment category, was $3.1 million at
December 31, 2005. We had $4.2 million in Fed Funds Sold at December 31,
2007, compared to $18.2 million at December 31, 2006, and $33.2 million at
December 31, 2005.





At the date of purchase, we are
required to classify equity and debt securities into one of three categories:
held-to-maturity, trading, or available-for-sale. At each annual reporting date,
the appropriateness of the classification is reassessed. Investments classified
as held-to-maturity are measured at amortized cost in the financial statements
and can be so classified only if management has the positive intent and ability
to hold those securities to maturity. Securities that are bought and held
principally for the purpose of sale in the near-term are classified as trading
and measured at fair value in the financial statements with unrealized gains and
losses included in earnings. Investments not classified as either
held-to-maturity or trading are classified as available-for-sale and measured at
fair value in the financial statements with unrealized gains and losses
reported, net of tax, in a separate component of shareholders' equity until
realized.





For 2007, the ratio of average
interest-earning assets to average total assets was 94.04%, for 2006 it was
91.21% and for 2005 it was 87.96%. Our goal is to maintain at least 90% of our
assets as interest-earning. For 2005 the ratio remained below that level due to
the SBA servicing asset, the related SBA interest-only strip receivable, and the
cash surrender value of life insurance. Even though these assets are not
considered interest-bearing for net interest margin purposes, they do produce,
or are related to, income that is part of non-interest income.




Other
Assets




Premises and equipment, accrued
interest, and deferred tax assets are the major components of other assets. The
changes in these items are as follows:


·
            Premises
      and equipment were $5.3 million, $5.5 million, and $4.9 million as of
      December 31, 2007, 2006, and 2005, respectively. The decrease has mainly
      been due to upgrades to information technology systems and expansion of
      the number of branches and loan production offices offset by
      depreciation.


·
            Accrued
      interest was $6.8 million, $6.2 million, and $3.5 million as of December
      31, 2007, 2006, and 2005, respectively. The increase in accrued interest
      is a direct result of the increase in loans (including loans
      held-for-sale).  Average loan balances increased to $1.20
      billion for 2007, compared to $922.3 million for 2006, and $634.7 million
      for 2005.


·
            Deferred
      tax assets were $10.1 million, $8.5 million, and $5.7 million as of
      December 31, 2007, 2006, and 2005, respectively. Over half of the deferred
      tax asset is due to the tax deductibility timing difference of the
      provision for loan loss.





45


Deposits





Sources
of Funds





We offer
a variety of deposit accounts, having a wide range of interest rates and terms,
consisting of demand, savings, money market, and time accounts. We rely
primarily on competitive pricing policies, customer service, and referrals to
attract and retain these deposits. Deposits were $1.16 billion at December 31,
2007, compared to $1.08 billion at December 31, 2006, a $79.6 million or 7.36%
increase. Demand deposits decreased $10.7 million, money market and NOW accounts
increased $15.9 million, savings decreased $1.7 million, and certificate of
deposits (CD's) increased $76.0 million, of which $88.2 million were brokered
deposits. Non interest-bearing demand deposits comprised approximately 12% of
deposits at December 31, 2007, compared to 13% at December 31, 2006. The loan to
deposit ratio increased to 106.60% at December 31, 2007 from 105.66% at December
31, 2006.





At
December 31, 2007, approximately 60% of deposits had balances of $100,000 or
more and none of our customers (excluding brokered deposits) had balances that
exceeded 2% of our bank’s deposits. Brokered CD deposits were $88.2 million at
December 31, 2007 and $47.2 million at December 31, 2006. We prefer core
deposits as a source of funds for our loan portfolio. Consequently, we take
steps to attract solid core accounts while at the same time maintaining a
reasonable funding cost. The core deposit base has grown as a result of the
addition of one branch in 2007, two branches in 2006, one branch in 2005, and
the continued deposit increases at our seven other branches. We will continue to
solicit core deposits to diminish reliance on volatile funds.





The
increase in certificates of deposits is due to CD promotions during 2004, 2005,
2006, and 2007 to fund the rapid loan growth, as well as the creation of a Money
Desk Department in 2005 and acquisition of brokered CD deposits in 2006 and
2007. Certificates of deposits balances in the Money Desk Department are
deposits from other financial institutions. As of December 31, 2007 these
deposits totaled $97.6 million. The following table is a summary of our deposits
by type and their percentage of distribution:





December
      31, 2007
            
            
            December
      31, 2006Amount
            
            Percent
            
            Amount
            
            PercentDeposit
      composition:
            (dollars
      in thousands)Non
      Interest-Bearing Demand
            $
            133,867
            
            12%
            
            $
            144,525
            
            13%Money
      Market and NOW
            
            146,270
            
            13%
            
            
            130,357
            
            12%Savings
            
            28,059
            
            2%
            
            
            29,781
            
            3%Time
      Deposits, Under $100,000
            
            453,272
            
            39%
            
            
            367,029
            
            34%Time
      Deposits, $100,000 and Over
            
            399,603
            
            34%
            
            
            409,809
            
            38%Total
      Deposits
            $
            1,161,071
            
            100%
            
            $
            1,081,501
            
            100%





On
November 2, 2006, the FDIC finalized a rule intended to match an
institution's deposit insurance premium to the risk an institution poses to the
deposit insurance fund. The final regulations adopt a new base schedule of
rates that the FDIC Board could adjust up or down, depending on the revenue
needs of the insurance fund. The base rates range from 2 to 4 basis points for
healthy banks, based on supervisory ratings and financial ratios, and debt
ratings for large banks. The new assessment rates were effective on January 1,
2007 and will vary between five and seven cents per $100 of domestic
deposits.





Borrowings
and Junior Subordinated Debt





We use
FHLB borrowings to fund loan demand and to manage liquidity in light of deposit
flows. Our borrowing capacity can be used to borrow under various FHLB loan
programs, including adjustable and fixed-rate financing, for periods ranging
from one day to 30 years, with a variety of interest rate structures available.
The borrowing capacity has no commitment fees or cost, requires minimum levels
of investment in FHLB stock (we receive dividend income on our investment in
FHLB stock), can be withdrawn by the FHLB if there is any significant change in
our financial or operating condition, and is conditional upon our compliance
with certain agreements covering advances, collateral maintenance, eligibility,
and documentation.


46


We are
required to pledge a certain amount of loans with the FHLB for collateralization
purposes. As of December 31, 2007, $129.8 million in loans, with an outstanding
balance of $124.3 million, was pledged for an aggregate borrowing line of $81.1
million. As of December 31, 2006, $124.1 million in loans, with an outstanding
balance of $112.8 million, was pledged for an aggregate borrowing line of $73.8
million. At December 31, 2006 and 2007, there were no borrowings from the FHLB.
At December 31, 2005, advances from the FHLB were $30.0 million. Our borrowing
capacity at the FHLB as of December 31, 2005 was $30.1 million.





Pursuant
to rulings of the Federal Reserve Board, bank holding companies are permitted to
issue long-term subordinated debt instruments that will, subject to certain
conditions, qualify as and, therefore, augment capital for regulatory purposes.
The Subordinated Debentures are subordinated to all of our existing and future
borrowings. The table below summarizes the terms of each issuance of our junior
subordinated debt securities as of December 31, 2007:





Series
            Amount
      (000's)
            
            Date Issued
            
            Rate
      Adjustor
            
            Effective
      Rate
            
            Maturity
      DateTemecula
      Valley Statutory Trust II
            $
            5,155
            
            September
      2003
            
            3-month
      LIBOR +2.95%
            
            8.64%
            
            2033Temecula
      Valley Statutory Trust III
            
            8,248
            
            September
      2004
            
            3-month
      LIBOR +2.20%
            
            7.13%
            
            2034Temecula
      Valley Statutory Trust IV
            
            8,248
            
            September
      2005
            
            3-month
      LIBOR +1.40%
            
            6.39%
            
            2035Temecula
      Valley Statutory Trust V
            
            12,372
            
            September
      2006
            
            3-month
      LIBOR +1.60%
            
            6.43%
            
            2036Total
            $
            34,023





At our
company level, trust preferred borrowings can be treated as tier one capital up
to 25% of total tier one capital, with the remainder treated as tier two
capital. As of December 31, 2007 we have included $33.0 million of the net
junior subordinated debt in our Tier I capital for regulatory capital purposes.
As of December 31, 2006 and 2005 we have included $31.1 million of the net
junior subordinated debt in our Tier I capital for regulatory capital purposes.
The remaining amount qualifies for Tier II capital treatment.




Capital




It is our
goal to maintain capital levels within the regulatory “well capitalized”
category. We update our multiple-year capital plan annually in conjunction with
the preparation of the annual budget. Capital levels are always a primary
concern of the federal regulatory authorities, and we submit capital plans to
them when requested. It is our strategy to maintain an adequate level of
capital, which by definition excludes excessive as well as inadequate
capital.





Total
capital was $108.0 million at December 31, 2007 and $103.3 million at December
31, 2006. For 2007, the $4.7 million, or 4.55% increase, consisted of $15.1
million of net income, $2.0 million on the exercise of stock options, $806
thousand of stock-based compensation expense, a reduction of $1.2 million for
cash dividends, and a reduction of $12.1 million for the repurchase and
retirement of common stock. For 2006, the $45.1 million, or 77.49% increase,
consisted of $16.9 million of net income, a reduction of $172 thousand in other
comprehensive income, $2.5 million on the exercise of stock options, $1.1
million of stock-based compensation expense, and $25.1 million of proceeds from
a private placement stock offering. Our average equity to average assets ratio
was 8.18%, 6.88%, and 6.96% at December 31, 2007, 2006, and 2005,
respectively.




During
2007, our board of directors authorized three cash dividends. The first cash
dividend was authorized in May 2007, a $0.04 per share cash dividend payable on
July 15, 2007 to shareholders of record as of July 1, 2007. The second cash
dividend was authorized in August 2007, a $0.04 per share cash dividend payable
on October 15, 2007 to shareholders of record as of October 1, 2007. The third
cash dividend was authorized in November 2007, a $0.04 per share cash dividend
payable on January 15, 2008 to shareholders of record as of January 2, 2008.
Whether or not stock dividends, or any cash dividends, will be paid in the
future will be determined by our Board of Directors after consideration of
various factors. Our company's and our bank's profitability and regulatory
capital ratios, in addition to other financial conditions, will be key factors
considered by our Board of Directors in making such determinations regarding the
payment of dividends.




Total
risk based capital was 10.80% and tier one leverage capital was 10.63% at
December 31, 2007, compared to 11.90% and 11.42% at December 31, 2006. At
December 31, 2007 and 2006 our bank was within the regulatory “well capitalized”
category.




At the end of 2007 and 2006, all bank
capital ratios were above all current Federal capital guidelines for a "well
capitalized" bank. Our management considers capital requirements as part of our
strategic planning process. The strategic plan calls for continuing increases in
assets and liabilities, and the capital required may therefore be in excess of
retained earnings. The ability to obtain capital is dependent upon the capital
markets as well as performance of our company. Our management regularly
evaluates sources of capital and the timing required to meet our strategic
objectives.


47


The
following tables present the regulatory standards for well capitalized
institutions and the capital ratios for our company and our bank at
December 31, 2007, 2006, and 2005.


Minimum
      Required for Capital Adequacy Purposes
            
            Actual
      Ratio
              December
      31,Temecula
      Valley Bancorp
            
            
            
            
            2007
            2006
            2005Tier
      1 leverage
            
            4.0%
            
            
            10.6%
            11.4%
            9.3%Tier
      1 risk-based capital
            
            4.0%
            
            
            9.7%
            10.5%
            8.9%Total
      risk-based capital
            
            8.0%
            
            
            10.8%
            11.9%
            11.0%





Minimum
      Required for Capital Adequacy Purposes
            
            To
      Be Well Capitalized Under Prompt Corrective Action
    Provisions
            
            Actual
      Ratio
              December
      31Temecula
      Valley Bank
            
            
            
            
            
            
            
            
            2007
            2006
            2005Tier
      1 leverage
            
            4.0%
            
            
            5.0%
            
            
            
            10.5%
            11.2%
            10.2%Tier
      1 risk-based capital
            
            4.0%
            
            
            6.0%
            
            
            
            9.5%
            10.2%
            9.8%Total
      risk-based capital
            
            8.0%
            
            
            10.0%
            
            
            
            10.7%
            11.2%
            10.8%





In
December 2006, the federal banking agencies issued final guidance to reinforce
sound risk management practices for bank holding companies and banks in
commercial real estate (“CRE”) loans. The guidance establishes CRE concentration
thresholds as criteria for examiners to identify CRE concentration that may
warrant further analysis. The implementation of these guidelines could result in
increased reserves and capital costs for banks with “CRE concentration”. We
believe that our CRE portfolio as of December 31, 2007 does not have the risks
associated with high CRE concentration due to mitigating factors, including low
loan-to-value ratios, adequate debt coverage ratios, and a wide variety of
property types.





Liquidity
Management





Our cash
position is determined on a daily basis. On a monthly basis, our Board reviews
our liquidity position. One analysis measures the liquidity gap. Our guidelines
state a 2% positive liquidity gap position should be maintained. At December 31,
2007, the liquidity gap position was 11.76%. Another analysis measures an
industry standard liquidity ratio. Our guidelines state a 10% ratio or more
should be maintained. At December 31, 2007 the ratio was 19.18%.





Our
primary sources of liquidity are derived from growth in customer deposits and
financing activities which includes Federal Funds lines of credit at
correspondent banks and Federal Home Loan Bank (“FHLB”) advances. We maintain
Federal Funds lines of credit of $58.0 million for short-term liquidity. In
addition, we have created a borrowing capacity at the FHLB that fluctuates with
loan balances pledged as collateral. At December 31, 2007, our borrowing
capacity with the FHLB was $81.1 million and at December 31, 2006 was $73.8
million. These funding sources are augmented by payments of principal and
interest on loans, and sales and participations of eligible loans. Primary uses
of funds include withdrawal of deposits, interest paid on deposits and
borrowings, originations of loans, and payment of operating expenses. We believe
our liquidity sources to be stable and adequate. At December 31, 2007, we were
not aware of any information that was reasonably likely to have a material
effect on our liquidity position.





Banks are in the business of managing
money. Consequently, funds management is essential to the ongoing profitability
of a bank. A bank must attract funds at a reasonable rate and deploy the funds
at an appropriate rate of return, while taking into account risk factors,
interest rates, short- and long-term liquidity positions, and profitability
needs. Liquidity management involves our ability to meet cash flow requirements
arising from fluctuations in deposit levels and demands of daily operations,
which include providing for customers' credit needs and ongoing repayment of
borrowings. Our liquidity is actively managed on a daily basis and reviewed
monthly by our Board of Directors.





We experienced net cash used by
operating activities of $11.3 million during the 2007, $62.4 million during
2006, and $25.6 million during 2005.





Net cash
provided by investing activities of $66.2 million during 2007, compared to net
cash used in investing activities of $304.7 million during 2006, and $192.8
million during 2005. The change in 2007 was primarily the result of the purchase
of the unguaranteed portion of 7(a) loans and the decreased loan growth in the
current year compared to strong growth in the prior year.


48


We
experienced net cash provided by financing activities of $61.5 million during
2007, $349.1 million during 2006, and $246.8 million during 2005. The change in
2007 was primarily the result of the repayment of a junior subordinated
debt   security, repurchase and retirement of common stock,
offset by a lower increase in time deposits.





The liquidity of our parent company is
primarily dependent on the payment of cash dividends by our bank, subject to
restrictions set forth by California Banking Law as well as other regulatory
instructions. The bank paid $13.0 million in dividends to the company in 2007.
For the year ended December 31, 2006 and 2005, no dividends were paid by our
bank to our company.





Contractual
Obligations and Commitments





At December 31, 2007, we had
commitments to extend credit of $448.8 million and obligations under letters of
credit of $11.4 million. Commitments to extend credit are agreements to lend to
customers, provided there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Commitments are generally variable
rate, and many of these commitments are expected to expire without being drawn
upon. As such, the total commitment amounts do not necessarily represent future
cash requirements. We use the same credit underwriting policies in granting or
accepting such commitments or contingent obligations as we do for
on-balance-sheet instruments, which consist of evaluating customers'
creditworthiness individually.





Standby letters of credit are
conditional commitments issued by us to guarantee the financial performance of a
customer to a third party. Those guarantees are primarily issued to support
private borrowing arrangements. The credit risk involved in issuing letters of
credit is essentially the same as that involved in extending loan facilities to
customers. When deemed necessary, we hold appropriate collateral supporting
those commitments. We do not anticipate any material losses as a result of these
transactions.





The
following tables set forth the maturities of our outstanding financial
commitments as of December 31, 2007 and 2006.





Maturities
      for Loan Commitments and Related Financial Instruments as of December 31,
      2007Maturity
      by periodOne
      year
            
            More
      than 1
            
            More
      than 3
            
            More
      thanTotal
            
            or
      less
            
            year
      to 3 years
            
            years
      to 5 years
            
            5
      years(dollars
      in thousands)Commitments
      to Extend Credit
            $
            448,837
            
            $
            288,298
            
            $
            69,721
            
            $
            1,668
            
            $
            89,150Letters
      of Credit
            
            11,447
            
            
            8,368
            
            
            2,952
            
            
            -
            
            
            127Loan
      Commitments Outstanding
            
            460,284
            
            
            296,666
            
            
            72,673
            
            
            1,668
            
            
            89,277Junior
      Subordinated Debt
            
            34,023
            
            
            -
            
            
            -
            
            
            -
            
            
            34,023Operating
      Lease Obligations
            
            4,964
            
            
            1,839
            
            
            2,164
            
            
            745
            
            
            216Other
      Commitments Outstanding
            
            38,987
            
            
            1,839
            
            
            2,164
            
            
            745
            
            
            34,239Total
      Outstanding Commitments
            $
            499,271
            
            $
            298,505
            
            $
            74,837
            
            $
            2,413
            
            $
            123,516Maturities
      for Loan Commitments and Related Financial Instruments as of December 31,
      2006Maturity
      by periodOne
      year
            
            More
      than 1
            
            More
      than 3
            
            More
      thanTotal
            
            or
      less
            
            year
      to 3 years
            
            years
      to 5 years
            
            5
      years(dollars
      in thousands)Commitments
      to Extend Credit
            $
            398,354
            
            $
            290,719
            
            $
            66,311
            
            $
            1,172
            
            $
            40,152Letters
      of Credit
            
            3,514
            
            
            3,130
            
            
            384
            
            
            -
            
            
            -Loan
      Commitments Outstanding
            
            401,868
            
            
            293,849
            
            
            66,695
            
            
            1,172
            
            
            40,152Junior
      Subordinated Debt
            
            41,240
            
            
            -
            
            
            -
            
            
            -
            
            
            41,240Operating
      Lease Obligations
            
            5,492
            
            
            1,831
            
            
            2,401
            
            
            879
            
            
            381Other
      Commitments Outstanding
            
            46,732
            
            
            1,831
            
            
            2,401
            
            
            879
            
            
            41,621Total
      Outstanding Commitments
            $
            448,600
            
            $
            295,680
            
            $
            69,096
            
            $
            2,051
            
            $
            81,773




49


Critical
Accounting Policies and Estimates





Our
accounting policies are integral to understanding the results reported. In
preparing our consolidated financial statements, we are required to make
judgments and estimates that may have a significant impact upon our financial
results. Certain accounting policies require us to make significant estimates
and assumptions, which have a material impact on the carrying value of certain
assets and liabilities, and are considered critical accounting policies. The
estimates and assumptions used are based on historical experiences and other
factors, which are believed to be reasonable under the circumstances. Actual
results could differ significantly from these estimates and assumptions, which
could have a material impact on the carrying value of assets and liabilities at
the balance sheet dates and results of operations for the reporting
periods.





The
discussion and analysis of our financial condition and results of operations are
based upon our consolidated financial statements, which have been prepared in
accordance with generally accepted accounting principles in the United States of
America. The preparation of these financial statements requires management to
make estimates and judgments that affect the reported amounts of assets and
liabilities, revenues and expenses, and related disclosures of contingent assets
and liabilities at the date of our financial statements. Actual results may
differ from these estimates under different assumptions or
conditions.





Significant accounting policies
followed by our company are presented in Note A to the consolidated
financial statements. These policies, along with the disclosures presented in
the other financial statement notes and in this discussion, provide information
on how significant assets and liabilities are valued in the financial statements
and how those values are determined. Based on the valuation techniques used and
the sensitivity of financial statement amounts to the methods, assumptions, and
estimates underlying those amounts, management has identified the allowance for
loan losses, stock based compensation expense, SBA servicing assets, and SBA I/O
strips to be the accounting areas that require the most subjective or complex
judgments, and as such could be most subject to revision as new information
becomes available.
  ITEM
7A: QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK









We do not
currently engage in trading activities or use derivative instruments to control
interest rate risk, even though such activities may be permitted with the
approval of our Board. We are most affected by interest rate risk. Other types
of market risk, such as foreign currency exchange risk, equity price risk and
commodity price risk, are not significant to us in the normal course of our
business activities.





Market
risk is the possible chance of loss from unfavorable changes in market prices
and rates. These changes may result in a reduction of current and future period
net interest income, which is the favorable spread earned from the excess of
interest income on interest-earning assets over interest expense on
interest-bearing liabilities.





Asset/Liability
Management





Interest rate risk ("IRR") and credit
risk are the two greatest sources of financial exposure for insured financial
institutions. IRR represents the impact that changes in absolute and relative
levels of market interest rates may have upon our net interest income ("NII").
Changes in the NII are the result of changes in the net interest spread between
interest-earning assets and interest-bearing liabilities (timing risk), the
relationship between various rates (basis risk), and changes in the shape of the
yield curve.





We realize a significant portion of our
income from the differential or spread between the interest earned on loans,
investments, other interest-earning assets, and the interest incurred on
deposits and borrowings. The volumes and yields on loans, deposits, and
borrowings are affected by market interest rates. As of December 31, 2006,
approximately 95% of our loan portfolio was tied to adjustable rate indices. The
majority of the adjustable rate loans are tied to the Wall Street Journal prime
rate and reprice immediately. The exception is 7(a) loans, which reprice on the
first day of the subsequent quarter after a change in prime. As of December 31,
2007, approximately 74% of our deposits were time deposits with a stated
maturity (generally one year or less) and a fixed rate of interest. As of
December 31, 2007, 100% of our junior subordinated debt was floating rate with a
remaining term of 25-30 years.





Changes in the market level of interest
rates directly and immediately affect our interest spread, and therefore
profitability. Sharp and significant changes to market rates can cause the
interest spread to shrink or expand significantly in the near term, principally
because of the timing differences between the adjustable rate loans and the
maturities (and therefore repricing) of the deposits and
borrowings.


50


The
ongoing monitoring and management of both interest rate risk and liquidity, in
the short- and long-term time horizon, is an important component of our
asset/liability management process, which is governed by limits established in
the policies reviewed and approved annually by our Board. We do not believe it
is possible to reliably predict future interest rate movements, but instead
maintain an appropriate process and set of measurement tools which enable us to
identify and quantify sources of interest rate risk in varying rate
environments. Our primary tool in managing interest rate risk is the effect of
interest rate shocks on the net interest income.





The
following shows our projected net interest income sensitivity for 2008 based on
asset and liability levels using the December 31, 2007 net interest income as a
starting point. For purposes of this table, there is assumed to be zero growth
in loans, investments, deposits, or other components of the balance sheet. At
December 31, 2007, our internal prime rate was 10.00% and Wall Street Journal
prime rate was 7.25%.





Changes
      in
            Projected
      Net
            
            
            Change
      from
            %
      Change fromRates
            Interest
      Income
            
            
            Base
      Case
            base
      Case(dollars
      in thousands)-300
            bp
            $
            45,836
            
            $
            (14,264)
            (23.73%)-200
            bp
            
            50,753
            
            
            (9,347)
            (15.55%)-100
            bp
            
            55,445
            
            
            (4,655)
            (7.75%)0
            bp
            
            60,100
            
            
            -
            0.00%+100
            bp
            
            65,659
            
            
            5,559
            9.25%+200
            bp
            
            71,657
            
            
            11,557
            19.23%+300
            bp
            
            77,642
            
            
            17,542
            29.19%





In the
model, a rising rate environment will increase net interest income (NII) from a
flat rate environment. A lower rate environment will decrease net interest
income. The analysis does not represent a forecast and should not be relied upon
as being indicative of expected operating results. These hypothetical estimates
are based upon various assumptions. Actual results will differ from simulated
results due to timing, magnitude, and frequency of interest rate changes, as
well as changes in market conditions and management strategy. While the
assumptions are developed upon current economic and market conditions, we cannot
make any assurances as to the predictive nature of these assumptions.
Furthermore, the sensitivity analysis does not reflect actions our Board might
take in responding to or anticipating changes in interest rates.





ITEM
8:                      FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA





The
financial statements of our company, including the “Report of Independent
Registered Public Accounting Firm” of our independent registered public
accounting firm are included in this report immediately following Part IV and
incorporated in this Item 8 by this reference.
  ITEM 9:  CHANGES IN AND DISAGREEMENTS
WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE







None


ITEM 9A:  CONTROLS AND
PROCEDURES







As of
December 31, 2007, we carried out an evaluation under the supervision and with
the participation of our management, including our company’s chief executive
officer and our company’s chief financial officer of the effectiveness and
design of our “disclosure controls and procedures,” pursuant to
Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as
amended. Based upon that evaluation, our chief executive officer and chief
financial officer concluded that our disclosure controls and procedures are
effective as of December 31, 2007. There have been no significant changes in our
internal controls that occurred during the quarter ended December 31, 2007
that has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.





Management’s
Annual Report On Internal Control Over Financial Reporting





Management
of our company is responsible for establishing and maintaining effective
internal control over financial reporting as defined in Rules 13a-15(f).
Internal control over financial reporting is a process designed to provide
reasonable assurance to our company’s management and board of directors
regarding the preparation and fair presentation of published financial
statements in accordance with generally accepted accounting
principles.
 51


Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate. Therefore, even those systems
determined to be effective can provide only reasonable assurance with respect to
financial statement preparation and presentation.





Management
performed an assessment of the effectiveness of our internal control over
financial reporting as of December 31, 2007 based upon criteria in Internal
Control — Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (“COSO”). Based on this assessment,
management believes that our company’s internal control over financial reporting
was effective as of December 31, 2007.





Our
company’s independent registered public accounting firm has audited our
company’s internal control over financial reporting as of December 31, 2007. The
report by Crowe Chizek and Company LLP appears on page 55 of this Form
10-K.





ITEM
9B:                      OTHER
INFORMATION





None


PART III





ITEM
10:                      DIRECTORS, EXECUTIVE
OFFICERS ANDCORPORATE
GOVERNANCE





The
information required by this Item is incorporated by reference from our
definitive Proxy Statement to be filed with the SEC pursuant to Regulation 14A
within 120 days after the fiscal year covered by this Annual Report ("our Proxy
Statement") under the caption “Information About Officers and Directors" and
"Section 16(a) Beneficial Ownership Reporting Compliance." If our proxy
statement is not filed within such 120 day period, the information will be
included in an amendment to this report filed with the SEC on Form 10-K/A not
later than the end of such 120 day period.





With
regard to Item 406, we have adopted a Code of Business Conduct and Ethics that
applies to its principal executive officer, principal financial officer and
controller. The policy may be viewed at our website at www.temvalbank.com.
Neither our website, nor the hyperlinks within our website are incorporated into
this document.





ITEM
11:                      EXECUTIVE
COMPENSATION





The
information required by this Item is incorporated by reference from our Proxy
Statement for the 2008 Annual Meeting of Shareholders under the caption
"Executive Officer Compensation and Analysis" and “Director Compensation”. If
our proxy statement is not filed within such 120 day period, the information
will be included in an amendment to this report filed with the SEC on Form
10-K/A not later than the end of such 120 day period.




ITEM 12. SECURITY OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS AND MANAGEMENTAND RELATED STOCKHOLDER
MATTERS









The
information required by this Item is incorporated by reference our Proxy
Statement for the 2008 Annual Meeting of Shareholders under the caption
"Beneficial Ownership" and “Securities Authorized for Issuance Under Equity
Compensation Plans”. If our proxy statement is not filed within such 120 day
period, the information will be included in an amendment to this report filed
with the SEC on Form 10-K/A not later than the end of such 120 day
period.




ITEM 13. CERTAIN RELATIONSHIPS AND
RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE







The
information required by this Item is incorporated by reference from our Proxy
Statement for the 2008 Annual Meeting of Shareholders under the caption "Certain
Relationships and Other Transactions." If our proxy statement is not filed
within such 120 day period, the information will be included in an amendment to
this report filed with the SEC on Form 10-K/A not later than the end of such 120
day period.


52


ITEM 14. PRINCIPAL ACCOUNTING FEES
AND SERVICES







The
information required by this Item is incorporated by reference from our Proxy
Statement for the 2008 Annual Meeting of Shareholders under the caption
"Independent Registered Public Accounting Firm Fees and Services." If our proxy
statement is not filed within such 120 day period, the information will be
included in an amendment to this report filed with the SEC on Form 10-K/A not
later than the end of such 120 day period.





PART IV




ITEM 15: EXHIBITS AND FINANCIAL
STATEMENT SCHEDULES







(a)(1),
(a)(2) and
(c)                                           Financial
Statements and Financial Statement Schedules





Reference
is made to the financial statements beginning at page 51 of this Form 10-K.
Financial Statement Schedules have been omitted because they are not applicable,
not material or because the information is included in the consolidated
financial statements or the notes.





(a)(3)           Exhibits





The exhibit list immediately precedes the exhibits at page 79 all of which are
incorporated herein by reference.





53




SIGNATURES


Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Company has duly caused this Annual Report to be signed on its behalf
by the undersigned, thereunto duly authorized.








TEMECULA
VALLEY BANCORP INC.





DATE:  March
17,
2008                                                                BY:           /s/
Stephen H. Wacknitz


Stephen H. Wacknitz,
President/CEO,


Chairman of the
Board





BY:           /s/
Donald A. Pitcher







Donald A.
Pitcher, Executive Vice President


Chief
Financial Officer





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




Signature
              Title
              Date/s/
      Steven W. AichleDirector
              March
      17, 2008Dr.
      Steven W. Aichle/s/
      Dr. Robert P. BeckDirector
              March
      17, 2008Dr.
      Robert P. Beck/s/
      Neil M. ClevelandDirector
              March
      17, 2008Neil
      M. Cleveland/s/
      George CossoliasDirector
              March
      17, 2008George
      Cossolias/s/
      Luther J. MohrDirector
              March
      17, 2008Luther
      J. Mohr/s/
      Stephen H. WacknitzChairman
              March
      17, 2008Stephen
      H. Wacknitz/s/
      Richard W. WrightRichard
      W. Wright
              Director
              March
      17, 2008


54


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM





Board of
Directors and Shareholders of


Temecula
Valley Bancorp Inc. and Subsidiary


Temecula,
California





We have
audited the accompanying consolidated statements of financial condition of
Temecula Valley Bancorp Inc. and Subsidiary (the Company) as of December 31,
2007 and 2006, and the related consolidated statements of income, changes in
shareholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 2007. We have also audited the Company’s Internal
Control Over Financial Reporting as of December 31, 2007, based on criteria
established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission(COSO). The Company’s management is
responsible for these financial statements, for maintaining effective internal
control over financial reporting and for its assessment of the effectiveness of
internal control over financial reporting in the accompanying Management’s
Annual Report on Internal Control Over Financial Reporting, included in Item 9A
of the accompanying Form 10-K. Our responsibility is to express an opinion on
these financial statements and an opinion on the effectiveness of the Company’s
internal control over financial reporting based on our audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement and whether effective internal
control over financial reporting was maintained in all material respects. Our
audits of the financial statements included examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the account principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. Our audit of internal
control over financial reporting included obtaining an understanding of internal
control over financial reporting, assessing the risk a material misstatement
exists, testing and evaluating the design and operating effectiveness of
internal control, based on the assessed risk. Our audits also included
performing such other procedures as we considered necessary in the
circumstances. We believe that our audits provide a reasonable basis for our
opinions.





A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.





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





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Temecula Valley Bancorp Inc.
and Subsidiary as of December 31, 2007 and 2006, and the results of their
operations and their cash flows for the years in the three-year period ended
December 31, 2007 in conformity with accounting principles generally accepted in
the United States of America. Also in our opinion, the Company maintained, in
all material respects, effective internal control over financial reporting as of
December 31, 2007, based on criteria established in Internal Control-Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission(COSO).








Crowe
Chizek and Company LLP


Oak
Brook, Illinois


March 17,
2008


55


CONSOLIDATED FINANCIAL STATEMENTS


TEMECULA
      VALLEY BANCORP INC. AND SUBSIDIARYCONSOLIDATED
      STATEMENTS OF FINANCIAL CONDITION(in
      thousands, except share and per share data)December
      31,ASSETS
            2007
            
            2006Cash
      and Due from Banks
            $
            13,210
            
            $
            15,190Federal
      Funds Sold
            
            4,220
            
            
            18,180TOTAL
      CASH AND CASH EQUIVALENTS
            
            17,430
            
            
            33,370Interest-bearing
      deposits in financial institutions
            
            1,000
            
            
            99FNMA
      Mortgage-backed Security HTM
              (fair
      value of $3,046 at December 31, 2007 and $1,029 at December 31,
      2006)
            
            2,981
            
            
            1,019Loans
      Held-for-Sale
            
            207,391
            
            
            173,120Loans:Commercial
            
            68,761
            
            
            59,663Real
      Estate - Construction
            
            481,849
            
            
            462,562Real
      Estate - Other
            
            229,123
            
            
            246,095SBA
            
            248,908
            
            
            201,105Consumer
      and other
            
            3,632
            
            
            3,684TOTAL
      LOANS HELD IN PORTFOLIO
            
            1,032,273
            
            
            973,109Net
      Deferred Loan Fees
            
            (1,947)
            
            
            (3,536)Allowance
      for Loan Losses
            
            (16,022)
            
            
            (12,522)TOTAL
      NET LOANS HELD IN PORTFOLIO
            
            1,014,304
            
            
            957,051Federal
      Home Loan Bank Stock, at Cost
            
            2,905
            
            
            1,996Premises
      and Equipment
            
            5,271
            
            
            5,492Other
      Real Estate Owned
            
            -
            
            
            1,255Cash
      Surrender Value of Life Insurance
            
            28,034
            
            
            24,036Deferred
      Tax Assets
            
            12,298
            
            
            8,480SBA
      Servicing Assets
            
            5,350
            
            
            8,288SBA
      Interest-Only Strips Receivable
            
            6,599
            
            
            13,216Accrued
      Interest Receivable
            
            6,827
            
            
            6,155Other
      Assets
            
            8,135
            
            
            4,612TOTAL
      ASSETS
            $
            1,318,525
            
            $
            1,238,189LIABILITIES
      AND SHAREHOLDERS' EQUITYDeposits:Non
      Interest-Bearing Demand
            $
            133,867
            
            $
            144,525Money
      Market and NOW
            
            146,270
            
            
            130,357Savings
            
            28,059
            
            
            29,781Time
      Deposits, Under $100,000
            
            453,272
            
            
            367,029Time
      Deposits, $100,000 and Over
            
            399,603
            
            
            409,809TOTAL
      DEPOSITS
            
            1,161,071
            
            
            1,081,501Accrued
      Interest Payable
            
            2,329
            
            
            2,094Junior
      Subordinated Debt
            
            34,023
            
            
            41,240Dividend
      Payable
            
            405
            
            
            -Other
      Liabilities
            
            12,738
            
            
            10,091TOTAL
      LIABILITIES
            
            1,210,566
            
            
            1,134,926Shareholders'
      Equity:Common
      Stock No Par Value; 40,000,000 SharesAuthorized;
      10,147,910 and 10,586,659 Shares Issuedand
      Outstanding at December 31, 2007 and December 31, 2006
            
            37,178
            
            
            46,383Accumulated
      other comprehensive (loss)
            
            -
            
            
            (172)Retained
      Earnings
            
            70,781
            
            
            57,052TOTAL
      SHAREHOLDERS' EQUITY
            
            107,959
            
            
            103,263TOTAL
      LIABILITIES AND SHAREHOLDERS' EQUITY
            $
            1,318,525
            
            $
            1,238,189


See accompanying notes to
the consolidated financial statements


56


TEMECULA
      VALLEY BANCORP INC. AND SUBSIDIARYCONSOLIDATED
      STATEMENTS OF INCOMEFor
      the Years Ended December 31, 2007, 2006, and 20052007
            
            2006
            
            2005INTEREST
      INCOME
            (dollars
      in thousands except share and per share data)Loans,
      including fees
            $
            114,190
            
            $
            93,378
            
            $
            57,880Interest-bearing
      deposits in financial institutions
            
            31
            
            
            3
            
            
            -Federal
      Funds Sold
            
            1,270
            
            
            829
            
            
            239Investment
      Securities
            
            124
            
            
            19
            
            
            6TOTAL
      INTEREST INCOME
            
            115,615
            
            
            94,229
            
            
            58,125INTEREST
      EXPENSEMoney
      Market and NOW
            
            4,492
            
            
            2,773
            
            
            961Savings
      Deposits
            
            127
            
            
            122
            
            
            141Time
      Deposits
            
            42,373
            
            
            28,819
            
            
            11,848Junior
      Subordinated DebtSecurities
      and Other Borrowings
            
            2,991
            
            
            2,735
            
            
            1,634TOTAL
      INTEREST EXPENSE
            
            49,983
            
            
            34,449
            
            
            14,584NET
      INTEREST INCOME
            
            65,632
            
            
            59,780
            
            
            43,541Provision
      for Loan Losses
            
            4,600
            
            
            3,650
            
            
            2,897NET
      INTEREST INCOME AFTERPROVISION
      FOR LOAN LOSSES
            
            61,032
            
            
            56,130
            
            
            40,644NON
      INTEREST INCOMEService
      Charges and Fees
            
            604
            
            
            618
            
            
            604Gain
      on Sale of Loans
            
            10,124
            
            
            13,165
            
            
            13,391Gain(Loss)
      on Other Assets
              and
      Other Real Estate Owned
            
            (25)
            
            
            67
            
            
            (22)Servicing
      Income (loss)
            
            (4,305)
            
            
            (2,615)
            
            
            2,638Loan
      Broker Income
            
            5,104
            
            
            4,314
            
            
            3,391Loan
      Related Income
            
            2,720
            
            
            2,216
            
            
            2,392Other
      Income
            
            2,166
            
            
            1,679
            
            
            1,428TOTAL
      NON INTEREST INCOME
            
            16,388
            
            
            19,444
            
            
            23,822NON
      INTEREST EXPENSESalaries
      and Employee Benefits
            
            33,557
            
            
            31,989
            
            
            26,971Occupancy
      Expenses
            
            3,219
            
            
            3,035
            
            
            2,428Furniture
      and Equipment
            
            1,929
            
            
            1,719
            
            
            1,512Data
      Processing
            
            1,381
            
            
            1,265
            
            
            1,127Marketing
      and Business Promotion
            
            1,176
            
            
            971
            
            
            1,122Legal
      and Professional
            
            1,387
            
            
            1,143
            
            
            1,055Regulatory
      Assessments
            
            765
            
            
            185
            
            
            246Travel
      & Entertainment
            
            1,075
            
            
            1,125
            
            
            948Loan
      Related Expense
            
            3,141
            
            
            2,367
            
            
            2,138Office
      Expenses
            
            2,640
            
            
            2,596
            
            
            2,677Other
      Expenses
            
            1,635
            
            
            596
            
            
            403TOTAL
      NON INTEREST EXPENSE
            
            51,905
            
            
            46,991
            
            
            40,627INCOME
      BEFORE INCOME TAX EXPENSE
            
            25,515
            
            
            28,583
            
            
            23,839Income
      Tax expense
            
            10,377
            
            
            11,663
            
            
            9,886NET
      INCOME
            $
            15,138
            
            $
            16,920
            
            $
            13,953Per
      Share Data :Net
      Income - Basic
            
            $1.45
            
            
            $1.83
            
            
            $1.58Net
      Income - Diluted
            
            $1.41
            
            
            $1.73
            
            
            $1.46Cash
      dividend declared per common share
            
            $0.12
            
            
            N/A
            
            
            N/A





See
accompanying notes to the consolidated financial statements


57




CONSOLIDATED
      STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITYFor
      the Years Ended December 31, 2007, 2006, and 2005AccumulatedCommon
            
            
            
            
            
            OtherComprehensive
            
            
            
            Stock
            
            
            Retained
            
            
            ComprehensiveIncome
            Shares
            
            
            &
      Surplus
            
            
            Earnings
            
            
            Income
      (loss)
            
            
            Totalin
      thousands, except per share data)Balance
      at January 1, 2005
            
            
            8,753
            
            $
            16,724
            
            $
            26,179
            
            $
            -
            
            $
            42,903Exercise
      of Stock Options,Including
      the Realization of
              Tax
      Benefits of $40
            
            
            145
            
            
            916
            
            
            
            
            
            
            
            
            916Net
      Income
            
            13,953
            
            
            
            
            
            
            13,953
            
            
            
            
            
            13,953Other
      comprehensive income(loss), net
            
            409
            
            
            
            
            
            
            
            
            
            409
            
            
            409Total
      comprehensive income
            $
            14,362Balance
      at December 31, 2005
            
            
            8,898
            
            $
            17,640
            
            $
            40,132
            
            $
            409
            
            $
            58,181Exercise
      of Stock Options,Including
      the Realization of
              Tax
      Benefits of $1,379
            
            
            288
            
            
            2,493
            
            
            
            
            
            
            
            
            2,493Private
      Placement Stock Offering, net
            
            
            1,401
            
            
            25,137
            
            
            
            
            
            
            
            
            25,137Stock-based
      compensation
            
            
            
            
            
            1,113
            
            
            
            
            
            
            
            
            1,113Net
      Income
            
            16,920
            
            
            
            
            
            
            16,920
            
            
            
            
            
            16,920Other
      comprehensive (loss), net
            
            (581)
            
            
            
            
            
            
            
            
            
            (581)
            
            
            (581)Total
      comprehensive income
            $
            16,339Balance
      at December 31, 2006
            
            
            10,587
            
            $
            46,383
            
            $
            57,052
            
            $
            (172)
            
            $
            103,263Exercise
      of Stock Options,Including
      the Realization of
              Tax
      Benefits of $1,127
            
            
            245
            
            
            2,050
            
            
            
            
            
            
            
            
            2,050Repurchase
      and retirement of common stock
            
            (684)
            
            
            (12,061)
            
            
            
            
            
            
            
            
            (12,061)Stock-based
      compensation
            
            
            
            
            
            806
            
            
            
            
            
            
            
            
            806Adjustment
      for adoption ofFASB
      155
            
            
            
            
            
            
            
            
            (172)
            
            
            172
            
            
            -Cash
      dividends
            
            
            
            
            
            
            
            
            (1,237)
            
            
            
            
            
            (1,237)Net
      Income
            
            
            
            
            
            
            
            
            15,138
            
            
            
            
            
            15,138Balance
      at December 31, 2007
            
            
            10,148
            
            $
            37,178
            
            $
            70,781
            
            $
            -
            
            $
            107,959





See
accompanying notes to the consolidated financial statements


58




TEMECULA
      VALLEY BANCORP INC. AND SUBSIDIARYCONSOLIDATED
      STATEMENTS OF CASH FLOWSFOR
      THE YEARS ENDED DECEMBER 31, 2007, 2006, and 20052007
            
            
            2006
            
            
            2005OPERATING
      ACTIVITIES
            (dollars
      in thousands)Net
      Income
            $
            15,138
            
            $
            16,920
            
            $
            13,953Adjustments
      to Reconcile Net Income to Net Cash Provided by Operating
      Activities:Provision
      for loan losses
            
            4,600
            
            
            3,650
            
            
            2,897Depreciation
      and amortization
            
            1,818
            
            
            13,139
            
            
            8,639Fair
      value adjustment on servicing assets and I/O strips
    receivable
            
            11,181
            
            
            -
            
            
            -Amortization
      of debt issuance cost
            
            49
            
            
            70
            
            
            70Net
      amortization of securities premiums
            
            74
            
            
            10
            
            
            -Net
      change in deferred loan origination fees
            
            (1,589)
            
            
            (1,312)
            
            
            (1,145)Provision
      for deferred taxes
            
            (1,615)
            
            
            (2,314)
            
            
            (1,670)Gain
      on sale of loans
            
            (10,124)
            
            
            (13,165)
            
            
            (13,391)Loans
      originated for sale
            
            (190,808)
            
            
            (250,846)
            
            
            (209,936)Proceeds
      from loan sales
            
            166,661
            
            
            173,704
            
            
            176,919Loss
      (gain) on sale of other real estate owned and fixed assets
            
            25
            
            
            (75)
            
            
            26Share-based
      compensation expense
            
            806
            
            
            1,113
            
            
            -Earnings
      on cash surrender value of life Insurance
            
            (998)
            
            
            (745)
            
            
            (507)Federal
      Home Loan Bank stock dividends
            
            (125)
            
            
            (97)
            
            
            (69)Net
      change in accrued interest, other assets and other
    liabilities
            
            (6,360)
            
            
            (2,532)
            
            
            (1,429)NET
      CASH USED IN OPERATING ACTIVITIES
            
            (11,267)
            
            
            (62,480)
            
            
            (25,643)INVESTING
      ACTIVITIESPurchases
      of held-to-maturity investments
            
            (2,636)
            
            
            (2,230)
            
            
            (1,194)Proceeds
      from maturities of held-to-maturity securities
            
            600
            
            
            1,201
            
            
            1,200Purchases
      of Federal Reserve and Federal Home Loan Bank stock
            
            (784)
            
            
            (45)
            
            
            (652)Proceeds
      from sale of Federal Reserve Bank stock
            
            -
            
            
            1,245
            
            
            -Net
      decrease (increase) in loans
            
            (42,829)
            
            
            (166,790)
            
            
            (183,664)Purchase
      of loans
            
            (77,814)
            
            
            (133,336)
            
            
            -Proceeds
      from first trust deed loan sales
            
            58,968
            
            
            -
            
            
            -Purchases
      of premises and equipment
            
            (1,455)
            
            
            (2,271)
            
            
            (1,727)Proceeds
      from sale of premises and equipment
            
            92
            
            
            131
            
            
            129Purchase
      of cash surrender value life insurance
            
            (3,000)
            
            
            (5,700)
            
            
            (7,490)Proceeds
      from sale of other real estate owned
            
            2,675
            
            
            3,062
            
            
            647NET
      CASH USED IN INVESTING ACTIVITIES
            
            (66,183)
            
            
            (304,733)
            
            
            (192,751)FINANCING
      ACTIVITIESNet
      increase in demand deposits and savings accounts
            
            3,533
            
            
            19,995
            
            
            30,908Net
      increase in time deposits
            
            76,037
            
            
            319,074
            
            
            176,757Net
      change in Federal Home Loan Bank advances
            
            -
            
            
            (30,000)
            
            
            30,000Retirement
      of junior subordinated debt securities
            
            (7,217)
            
            
            -
            
            
            -Proceeds
      from exercise of stock options
            
            923
            
            
            1,114
            
            
            876Proceeds
      from issuance of junior subordinated debt
            
            -
            
            
            12,372
            
            
            8,248Proceeds
      from private placement stock offering, net
            
            -
            
            
            25,137
            
            
            -Cash
      dividends on common stock
            
            (832)
            
            
            -
            
            
            -Repurchase
      and retirement of common stock
            
            (12,061)
            
            
            -
            
            
            -Excess
      tax benefits from exercise of stock options
            
            1,127
            
            
            1,379
            
            
            -NET
      CASH  PROVIDED BY FINANCING ACTIVITIES
            
            61,510
            
            
            349,071
            
            
            246,789INCREASE
      (DECREASE) IN CASH AND CASH EQUIVALENTS
            
            (15,940)
            
            
            (18,142)
            
            
            28,395Cash
      and cash equivalents at beginning of year
            
            33,370
            
            
            51,512
            
            
            23,117CASH
      AND CASH EQUIVALENTS AT END OF YEAR
            $
            17,430
            
            $
            33,370
            
            $
            51,512Supplemental
      Disclosures of Cash Flow Information:Interest
      paid
            $
            49,748
            
            $
            33,312
            
            $
            14,032Income
      taxes paid, net of refunds
            $
            11,500
            
            $
            9,307
            
            $
            13,794Transfer
      of loans to other real estate owned
            $
            1,411
            
            $
            2,131
            
            $
            2,482





See
accompanying notes to the consolidated financial statements


59


TEMECULA
VALLEY BANCORP INC.


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2007, 2006, and 2005


NOTE
A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Principles of
Consolidation





The
consolidated financial statements include the accounts of Temecula Valley
Bancorp Inc. ("company" or “our company” or “our holding company”), and its
wholly-owned subsidiary, Temecula Valley Bank ("bank" or “our bank”),
collectively referred to herein as the “Company”. Unless the context indicates
otherwise, all references in this report to “we”, “us”, and “our” refer to our
company and our bank on a consolidated basis. All significant intercompany
transactions have been eliminated.





Nature of
Operations





We have
been organized as a single operating segment and operate eleven full-service
banking offices located in Carlsbad, Corona, El Cajon, Escondido, Fallbrook,
Murrieta, Ontario, Solana Beach, San Marcos, Temecula, and the Rancho Bernardo
area of San Diego. We also operate loan production offices throughout the United
States. Those in Encinitas, Fallbrook, and Temecula, California principally
generate construction and/or mortgage loans. The loan production offices located
in Corona (serving Southern California) and San Rafael (serving Northern
California), California focus on construction lending. As a Nationwide Preferred
Lender, we have SBA loan production offices currently operating in the following
states: Arizona, California, Colorado, Florida, Indiana, Nebraska, Nevada, Ohio,
Oregon, Texas, and Washington.





We closed
all of our loan production offices located in the northeast and southeast areas
of the country, except one in Florida, in January 2007. To date, this
reorganization has resulted in cost savings greater than the income generated
from the closed offices. As a result of the reorganization, we place greater
emphasis and resources on generating SBA loans in the mid and western United
States.





Our
primary sources of revenue are providing loans to customers, who are
predominately small and middle-market businesses and individuals, and
originating government guaranteed loans for sale to institutional investors in
the secondary market. We also generate fee income by servicing the government
guaranteed loans.





Use of Estimates in the
Preparation of Financial Statements





We
prepare our financial statements, in conformity with U.S. generally accepted
accounting principles, which requires us to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of our financial statements and
the reported amounts of revenues and expenses during the reporting period.
Estimates associated with the allowance for loan losses, SBA servicing assets,
and SBA interest-only strips receivable are particularly susceptible to change.
Actual results could differ from those estimates.





Cash
Flows





For
purposes of reporting cash flows, cash and cash equivalents include cash, due
from banks, and federal funds sold. Generally, federal funds are sold for one
day periods. Net cash flows are reported for customer loan and deposit
transactions, as well as Federal Home Loan Bank advances.





Cash and Due From
Banks





We
maintain amounts with due from banks which at times exceed federally insured
limits. We have not experienced any losses in such accounts.





Investment
Securities





Debt
securities, for which we have the positive intent and ability to hold to
maturity, are reported at cost adjusted for premiums and discounts that are
recognized in interest income, using the interest method over the period to
maturity. Investments not classified as trading securities nor as
held-to-maturity securities are classified as available-for-sale securities and
recorded at fair value. Unrealized gains or losses on available-for-sale
securities are reported as a separate component of other comprehensive income
included in shareholders’ equity, net of taxes. Available-for-sale and
held-to-maturity securities are assessed at each reporting date to determine
whether there is an other-than-temporary impairment.


60


Impairments,
if any, are required to be recognized in current earnings rather than as a
separate component of shareholders’ equity. In estimating other-than-temporary
losses, our management considers: the length of time and extent that fair value
has been less than cost, the financial condition and near term prospects of the
issuer, and our ability and intent to hold the security for a period sufficient
to allow for any anticipated recovery in fair value. Realized gains or losses on
sales of held-to-maturity or available-for-sale securities are recorded using
the specific identification method.





At
December 31, 2007, we held two FNMA mortgage-backed securities, with an
amortized cost and fair value of $3.0 million, and are classified as
held-to-maturity. These securities were purchased in November 2006 and July 2007
and will mature in 2036 and 2037, respectively.





Loans
Held-for-Sale





SBA
loans, originated and intended for sale in the secondary market, are carried at
the lower of cost or estimated market value in the aggregate. Net unrealized
losses are recognized through a valuation allowance by charges to
income.





We are a
Nationwide SBA "Preferred Lender". As a Preferred Lender we can approve a loan
within the authority given to us by the SBA without prior approval from the SBA.
Preferred Lenders approve, package, fund, and service SBA loans within a range
of authority that is not available to other SBA lenders without the "Preferred
Lender" designation.





We
originate loans to customers under the SBA 7(a) program that generally provides
for SBA guarantees up to 85% of each loan. We generally sell the guaranteed
piece as well as a part of the unguaranteed portion of each loan. Approximately
5% of the 7(a) loans are required to stay on our books. The strategy of selling
both the guaranteed and unguaranteed portion of the 7(a) loans assists us in
managing our capital levels and meeting our funding needs relative to local
community loan demand.





We retain
the servicing on the sold guaranteed portion of 7(a) loans. Upon sale in the
secondary market, the purchaser of the guaranteed portion of 7(a) loans pays a
par or premium to us, which generally is between 4% and 8% of the guaranteed
amount, and in the case of a sale of the unguaranteed portion, the premium is
usually between 1% and 4%. For servicing we receive a fee equal to 1% to 4% of
the guaranteed amount sold in the secondary market.





Loans





Loans
receivable, that we have the intent and ability to hold for the foreseeable
future or until maturity or payoff, are reported at their outstanding unpaid
principal balances reduced by any charge-offs or allowance for loan losses and
net of any deferred fees or costs on originated loans, or unamortized premiums
or discounts on purchased loans. Interest income is accrued on the unpaid
principal balance. Loan origination fees and certain direct origination costs
are capitalized and recognized as an adjustment of the yield of the related
loan.





The
accrual of interest on impaired loans is discontinued when, in our opinion, the
borrower may be unable to meet payments as they become due or is 90 days or more
past due. When interest accrual is discontinued, all unpaid accrued interest is
reversed. Interest income is subsequently recognized only to the extent cash
payments are received.





Purchased
Loans





We have
purchased participations in the unguaranteed portions of SBA 7(a) loans based
upon their payment history and other selected underwriting criteria in
order to further diversify our loan portfolio portfolio. At December 31,
2007 and 2006, we had $156.0 and $120.3 million in outstanding purchased
participation balances. The participations are purchased from other
financial institutions that are eligible to participate in the SBA 7(a)
program. The participation agreements are tri-party agreements among
the selling financial institution, the SBA and us.





In
September 2006, we began a wholesale SBA program. The wholesale SBA program
currently plans to source its loans primarily from real estate mortgage
brokers. The wholesale program primarily participates in the SBA 504
program and similar products provided by the secondary market. Our primary
sources of income will be construction loan fees,


61


interest
income, premiums from loan sales, and loan referral fees. The wholesale SBA
program does not add any new products and uses loan referral sources that are
already used by our bank.  However, it will use mortgage brokers as its
primary source of business, whereby our current SBA business development
officers use a number of different sources.





Allowance for Loan
Losses





The
allowance for loan losses is a valuation allowance for probable incurred credit
losses established through charges to earnings in the form of a provision for
loan losses. Loan losses are charged against the allowance when we believe the
uncollectibility of a loan balance is confirmed. Subsequently, recoveries are
credited to the allowance.





Quarterly
detailed reviews are performed to identify the risks inherent in the loan
portfolio, assess the overall quality of our loan portfolio and the related
provision for loan losses to be charged to expense. Our analysis considers
general factors such as evaluation of collateral securing the credit, changes in
lending policies and procedures, economic trends, loan volume trends, changes in
lending management and staff, trends in delinquencies, nonaccruals and
charge-offs, changes in loan review and Board oversight, the effects of
competition, legal and regulatory requirements, and factors inherent to each
loan pool. Allocations of the allowance may be made for specific loans, but the
entire allowance is available for any loan that, in our judgment, should be
charged-off.





A loan is
considered impaired when, 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.
If a loan is impaired, a portion of the allowance is allocated so that the loan
is reported, net, at the present value of estimated future cash flows using the
loan’s existing rate or at the fair value of collateral if repayment is expected
solely from the collateral. Large groups of smaller balance homogeneous loans,
such as consumer and residential real estate loans, are collectively evaluated
for impairment, and accordingly, they are not separately identified for
impairment disclosures.





Servicing Rights and
Interest-Only Strips Receivable




Servicing
rights are recognized separately when they are acquired through sales of loans.
For sales of loans prior to January 1, 2007, a portion of the cost of the loan
was allocated to the servicing right based on relative fair
values.  We adopted SFAS No. 156 on January 1, 2007, and for sales of
loans beginning in 2007, servicing rights are initially recorded at fair value
with the income statement effect recorded in gains on sales of loans. Fair value
is based on market prices for comparable servicing contracts, when available, or
alternatively, is based on a valuation model that calculates the present value
of estimated future net servicing income. The valuation model incorporates
assumptions that market participants would use in estimating future net
servicing income, such as the cost to service, the discount rate, the custodial
earnings rate, an inflation rate, ancillary income, and prepayment speeds.
Our company compares the valuation model inputs and results to published
industry data in order to validate the model results and
assumptions.
 
 Under the
fair value measurement method, we measured servicing rights at fair value at
each reporting date and reports changes in fair value of servicing rights in
earnings in the period in which the changes occur, and the changes in fair value
are included with Servicing Income (Loss) on the income statement. The fair
values of servicing rights are subject to significant fluctuations as a result
of changes in estimated and actual prepayment speeds and estimated and actual
discount rates.
 
 Prior to
January 1, 2007, all servicing rights were subsequently measured using the
amortization method which required servicing rights to be amortized into
non-interest income in proportion to, and over the period of, the estimated
future net servicing income of the underlying loans. Additionally, prior to
January 1, 2007, servicing rights were evaluated for impairment based upon the
fair value of the rights as compared to carrying amount. Impairment was
determined by stratifying rights into groupings based on predominant risk
characteristics, such as interest rate, loan type and investor type. Impairment
was recognized through a valuation allowance for an individual grouping, to the
extent that fair value was less than the carrying amount. If we later determined
that all or a portion of the impairment no longer existed for a particular
grouping, a reduction of the allowance may have been recorded as an increase to
income.
 
 Servicing
fee income which is reported on the income statement as Servicing Income (Loss)
is recorded for fees earned for servicing loans. The fees are based on a
contractual percentage of the outstanding principal; or a fixed amount per loan
and are recorded as income when earned. The amortization of servicing rights was
netted against loan servicing fee income for the years ended December 31, 2006
and 2005. Servicing fees totaled $7.1, $9.1 and $10.3 million for the years
ended December 31, 2007, 2006 and 2005.
 
 In
February 2006, the FASB issued Statement of Financial Accounting Standards No.
155, Accounting for Certain
Hybrid Financial Instruments (SFAS No. 155), which permits fair value
remeasurement for hybrid financial instruments that contain an embedded
derivative that otherwise would require bifurcation. Additionally, SFAS No. 155
clarifies the accounting guidance for beneficial interests in securitizations.
Under SFAS No. 155, all beneficial interests in a securitization will require an
assessment in accordance with SFAS No. 133 to determine if an embedded
derivative exists within the instrument. In January 2007, the FASB issued
Derivatives Implementation Group Issue B40, Application of Paragraph 13(b) to
 62
 Securitized Interests in Prepayable
Financial Assets (DIG Issue B40). DIG Issue B40 provides an exemption
from the embedded derivative test of paragraph 13(b) of SFAS No. 133 for
instruments that would otherwise require bifurcation if the test is met solely
because of a prepayment feature included within the securitized interest and
prepayment is not controlled by the security holder. SFAS No. 155 and DIG Issue
B40 are effective for fiscal years beginning after September 15, 2006. The
adoption of SFAS No. 155 and DIG Issue B40 resulted in a cumulative-effect
adjustment increasing retained earnings by $172 thousand as of January 1,
2007.
 Interest-only
strips are initially recorded at fair value with changes recognized as a
component of servicing income (loss). Fair value is estimated by discounting
estimated future cash flows from the I/O strips using assumptions similar to
those used in valuing servicing rights. Prior to January 1, 2007 the
interest-only strips were accounted for as available-for-sale securities and
recorded at fair value with any unrealized gains or losses recorded in
accumulated other comprehensive income, net of tax.


Loan Sales
Recognition





To
calculate the gain (loss) on sale of loans, our company’s investment in the loan
is allocated among the retained portion of the loan, the servicing retained, the
interest-only strip, and the sold portion of the loan, based on the relative
fair market value of each portion. The gain (loss) on the sold portion of the
loan is recognized at the time of sale based on the difference between the sale
proceeds and the allocated investment. As a result of the relative fair value
allocation, the carrying value of the retained portion is discounted, with the
discount accreted to interest income over the life of the loan.





Other Real Estate
Owned





Real
estate properties acquired through, or in lieu of, loan foreclosure are
initially recorded at the lesser of the outstanding loan balance or the fair
value at the date of foreclosure minus estimated costs to sell. Any valuation
adjustments required at the time of foreclosure are charged to the allowance for
loan losses. After foreclosure, the properties are carried at the lower of
carrying value or fair value less estimated costs to sell. Any subsequent
valuation adjustments, operating expenses or income, and gains and losses on
disposition of such properties are recognized in current
operations.




Premises and
Equipment





Land is
carried at cost. Premises and equipment are carried at cost less accumulated
depreciation and amortization. Depreciation is computed using the straight-line
method over the estimated useful lives, which ranges from three to ten years for
furniture and fixtures and ten to thirty years for buildings. Leasehold
improvements are amortized using the straight-line method over the estimated
useful lives of the improvements or the remaining lease term, whichever is
shorter. Expenditures for betterments or major repairs are capitalized and those
for ordinary repairs and maintenance are charged to operations as
incurred.





Premises
and equipment are reviewed for impairment when events indicate their carrying
amount may not be recoverable from future undiscounted cash flows.  If
impaired, the assets are recorded at fair value.





Federal Home Loan Bank
(FHLB) Stock





Our bank
is a member of the FHLB system. Members are required to own a certain amount of
stock based on the level of borrowings and other factors, and may invest in
additional amounts. FHLB stock is carried at cost, classified as a restricted
security, and periodically evaluated for impairment based on ultimate recovery
of par value. Both cash and stock dividends are reported as income.





Cash Surrender Value of Life
insurance





We have
purchased life insurance policies on certain key executives. Upon adoption of
EITF 06-5, which is discussed further below, Company owned life insurance is
recorded at the amount that can be realized under the insurance contract at the
balance sheet date, which is the cash surrender value adjusted for other charges
or other amounts due that are probable at settlement. Prior to adoption of EITF
06-5, we recorded owned life insurance at its cash surrender value.





In
September 2006, the FASB Emerging Issues Task Force finalized Issue No. 06-5,
Accounting for Purchases of Life Insurance - Determining the Amount That Could
Be Realized in Accordance with FASB Technical Bulletin No. 85-4 (Accounting for
Purchases of Life Insurance). This Issue requires that a policyholder consider
contractual terms of a life insurance policy in determining the amount that
could be realized under the insurance contract. It also requires that if the
contract provides for a greater surrender value if all individual policies in a
group are surrendered at the same time, that the surrender value be determined
based on the assumption that policies will be surrendered on an individual
basis. Lastly, the Issue requires disclosure when there are contractual
restrictions on the Company’s ability to surrender a policy. The adoption of
EITF 06-5 on January 1, 2007 had no impact on our company’s financial condition
or results of operation.


63


Advertising





We
expense the costs of advertising in the period incurred.





Loan Commitments and Related
Financial Instruments





In the
ordinary course of business, we enter into off-balance sheet financial
instruments consisting of commitments to extend credit, commitments under credit
card arrangements, commercial letters of credit, and standby letters of credit.
Such financial instruments are recorded in our financial statements when they
are funded or related fees are incurred or received.





Stock-Based
Compensation





Prior to
January 1, 2006, we accounted for stock-based compensation using the intrinsic
value method prescribed in APB Opinion No. 25 and related Interpretations. We
measured the compensation cost for stock options as the excess, if any, of the
quoted market price of our stock at the date of the grant over the amount an
employee must pay to acquire the stock.





Effective
January 1, 2006, we adopted the modified prospective methodology of Financial
Accounting Standards Board (“FASB”) SFAS No. 123R, “Share-Based Payment”. Prior
to January 1, 2006, employee compensation expense under stock options was
reported using the intrinsic value method; therefore, no stock-based
compensation cost is reflected in net income for the year ended December 31,
2005, as all options granted had an exercise price equal to or greater than the
market price of the underlying common stock at date of grant.





The
following table illustrates the effect on net income and earnings per share
information had we accounted for share-based compensation in accordance with
SFAS No. 123, “Accounting for
Stock-Based Compensation”, for the year ended December 31,
2005.


2005(dollars
      in thousands)Net
      income, as reported
            $
            13,953Deduct:
      Total stock-based employee compensation expensedetermined
      under fair value based method for all awards,net
      of related tax effects
            
            (488)Pro
      Forma Net Income
            $
            13,465Per
      Share Data:Basic
      income per share, as reported
            
            $1.58Basic
      income per share, proforma
            
            $1.52Diluted
      income per share, as reported
            
            $1.46Diluted
      income per share, proforma
            
            $1.40





Income
Taxes





Deferred
income taxes are computed using the asset and liability method, which recognizes
a liability or asset representing the tax effects, based on current tax law, of
future deductible or taxable amounts attributable to events that have been
recognized in our consolidated financial statements. A valuation allowance is
established to reduce the deferred tax asset to the level at which it is “more
likely than not” that the tax asset or benefits will be realized. Realization of
tax benefits of deductible temporary differences and operating loss
carryforwards depend on having sufficient taxable income of an appropriate
character within the carryforward periods. We recognize interest and penalties
relating to income tax matters in income tax expense.





Transfers of Financial
Assets





Transfers
of financial assets are accounted for as sales, when control over the assets has
been relinquished. Control over transferred assets is deemed to be surrendered
when the assets have been isolated from our company, the transferee obtains the
right (free of conditions that constrain it from taking advantage of that right)
to pledge or exchange the transferred assets, and our company does not maintain
effective control over the transferred assets through an agreement to repurchase
them before their maturity.


64


Employee Stock Ownership
Plan (“ESOP”)





The
employee stock ownership plan was adopted in 2006 and is not leveraged.
Compensation expense is based on the market price of shares as they are awarded
to participant accounts. There are no shares committed to be purchased by our
company for allocating to the ESOP. Cash contributions are made at our company's
discretion.





Earnings Per Share
(EPS)





Basic EPS
excludes dilution and is computed by dividing income available to common
stockholders by the weighted-average number of common shares outstanding for the
period. Diluted EPS reflects the potential dilution that could occur if options
or other contracts to issue common stock were exercised or converted into common
stock or resulted in the issuance of common stock that then shared in the
earnings of our company.





Comprehensive
Income





Prior to
2007, comprehensive income consists of net income and other comprehensive
income. Other comprehensive income includes unrealized gains and losses on SBA
servicing interest-only strips, net of tax. At December 31, 2006, the unrealized
loss on the interest-only strip was $296 thousand which resulted in a reduction
of $581 thousand in other comprehensive income (net of $421 thousand in deferred
taxes). At December 31, 2005, the unrealized gain on the interest-only strip was
$706 thousand which resulted in $409 thousand of other comprehensive income (net
of $297 thousand in deferred taxes).




Loss
Contingencies





Loss
contingencies, including claims and legal actions arising in the ordinary course
of business, are recorded as liabilities when the likelihood of loss is probable
and an amount or range of loss can be reasonably estimated. We do not believe
there now are such matters that will have a material effect on our financial
statements.





Dividend
Restrictions





Banking
regulations require maintaining certain capital levels that may limit the
dividends paid by our bank to our holding company or by our holding company to
our shareholders.





Disclosure about Fair Value
of Financial Instruments





SFAS No. 107,
“Disclosures about Fair Value
of Financial Instruments”, specifies the disclosure of the estimated fair
value of financial instruments. Our estimated fair value amounts have been
determined by us using available market information and appropriate valuation
methodologies as described in a separate note. Considerable judgment is required
to develop the estimates of fair value. Accordingly, the estimates are not
necessarily indicative of the amounts we could have realized in a current market
exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value
amounts.





Operating
Segments





While the
chief decision-makers monitor the revenue streams of the various products and
services, operations are managed and financial performance is evaluated on a
company-wide basis. Operating segments are aggregated into one as operating
results for all segments are similar. Accordingly, all of our financial service
operations are considered by us to be aggregated in one reportable operating
segment.





Reclassifications





Certain
reclassifications were made to prior year’s presentation to conform to the
current year.





Adoption of New Accounting
Standards





In July
2006, the FASB issued Interpretation No. 48 (“FIN 48”) “Accounting for Uncertainty in Income
Taxes: an interpretation of FASB Statement No. 109.” This interpretation
clarifies the accounting for uncertainty in income taxes recognized in an
entity’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.”
FIN 48 prescribes a recognition threshold and measurement attribute for a tax
position taken or expected to be taken in a tax return. Under FIN 48, an
income tax position will be


65


recognized
if it is more likely than not that it will be sustained upon IRS examination,
based upon its technical merits. Once that status is met, the amount recorded
will be the largest amount of benefit that is greater than 50 percent
likely of being realized upon ultimate settlement. FIN 48 also provides
guidance on derecognition, classification, interest and penalties, accounting in
interim periods, disclosure, and transition. FIN 48 is effective as of the
beginning of fiscal years that begin after December 15, 2006.





We have
adopted FIN 48 effective January 1, 2007. There was no cumulative effect of
applying the provisions of FIN 48 and there was no material effect on our
provision for income taxes for the year ended December 31, 2007. The adoption of
FIN 48 had no effect on our financial condition or results of
operations.




Effect of Newly Issued but
Not Yet Effective Accounting Standards





Under
Emerging Issues Task Force (“EITF”) 06-4, “Accounting for Deferred Compensation
and Postretirement Benefit Aspects of Endorsement Split Dollar Life Insurance
Arrangements”, the EITF reached a consensus that requires the recognition
of a liability related to the postretirement benefits covered by an endorsement
split-dollar life insurance arrangement. The consensus highlights that the
employer who is the policy holder has a liability for the benefit it is
providing to the employee. The employer has agreed to maintain the insurance
policy in force for the employee's benefit during his retirement, then the
liability recognized during the employee's active service period should be based
on the future cost of insurance to be incurred during the employee's retirement.
Also, if the employer has agreed to provide the employee with a death benefit,
then the liability for the future death benefit should be recognized under SFAS
106. It is applicable for fiscal years beginning after December 15, 2007. The
adoption of this EITF did not have a significant impact on our financial
condition or results of operations.




In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial
Assets and Financial Liabilities-Including an Amendment of FASB Statement No.
115”. SFAS 159 permits an entity to choose to measure many financial
instruments and certain other items at fair value. Most of the provisions of
SFAS 159 are elective; however, the amendment to SFAS 115, Accounting for Certain Investments
in Debt and Equity Securities, applies to all entities with
available-for-sale or trading securities. For financial instruments elected to
be accounted for at fair value, an entity will report the unrealized gains and
losses in earnings. SFAS 159 is effective as of the beginning of an entity’s
first fiscal year that begins after November 15, 2007. The adoption of this
statement did not have a material impact on our financial condition or results
of operations.




In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”
which clarifies the principle that fair value should be based on the assumptions
market participants would use when pricing an asset or liability and establishes
a fair value hierarchy that prioritizes the information used to develop those
assumptions. Under the standard, fair value measurement would be separately
disclosed by level within the fair value hierarchy. SFAS 157 is effective for
financial statements issued for fiscal years beginning after November 15,
2007 (January 1, 2008 for us), and interim periods within those fiscal years,
with early adoption permitted. We do not expect the adoption of this standard
will have a significant impact on our financial condition or results of
operations.


NOTE
B – LOANS





Our loan
portfolio consists primarily of loans to borrowers within Temecula, California,
its surrounding communities, and the surrounding communities of the other
business loan centers. Although we seek to avoid concentrations of loans to a
single industry or based upon a single class of collateral, real estate and real
estate associated businesses are among the principal industries in our market
area and, as a result, our loan and collateral portfolios are, to some degree,
concentrated in those industries. We have no negative amortization loans, but do
have construction loans that pay interest out of interest reserve advances. The
interest reserve is funded through advances on the construction
loans.





We also
originated mortgage and SBA loans for sale to institutional investors. A
substantial portion of our revenues are from origination of loans guaranteed by
the Small Business Administration under its Section 7(a) program and sale of the
guaranteed portions of those loans. Funding for the Section 7(a) program depends
on annual appropriations by the U.S. Congress.





Under the SBA’s 7(a) program, loans in
excess of $150 thousand up to $2 million are guaranteed 75% by the SBA.
Generally, this guarantee may become invalid only if the loan does not meet the
SBA underwriting, documentation, and servicing guidelines. Loans under $150
thousand are guaranteed 85% by the SBA. At December 31, 2007 and 2006, $46.4
million and $46.6 million of loans and loans held-for-sale were guaranteed under
these programs.


66


NOTE
C – ALLOWANCE FOR LOAN LOSSES





A summary
of the changes in the allowance for loan losses as of December 31 2007, 2006,
and 2005 follows:





2007
            
            2006
            
            2005(dollars
      in thousands)Balance
      at Beginning of Year
            $
            12,522
            
            $
            9,039
            
            $
            6,362Additions
      to the Allowance Charged to Expense
            4,600
            
            
            3,650
            
            
            2,897Recoveries
      on Loans Charged Off
            
            236
            
            
            214
            
            
            32017,358
            
            
            12,903
            
            
            9,579Loans
      Charged Off
            
            (1,336)
            
            
            (381)
            
            
            (540)$
            16,022
            
            $
            12,522
            
            $
            9,039





The
following is a summary of the investment in impaired and nonperforming loans,
the related allowance for loan losses, and income recognized thereon as of
December 31, 2007, 2006, and 2005:


2007
            
            2006
            
            2005(dollars
      in thousands)Recorded
      Investment in Nonperforming Loans
            $
            30,936
            
            $
            19,124
            
            $
            7,951Guaranteed
      Portion of Nonperforming Loans
            
            (10,379)
            
            
            (10,335)
            
            
            (6,514)Net
      Non-Performing Loans
            $
            20,557
            
            $
            8,789
            
            $
            1,437Net
      impaired loans with allocated allowance for loan loss
            $
            10,067
            
            $
            2,436
            
            $
            825Related
      Allowance for impaired Loans
            $
            1,854
            
            $
            615
            
            $
            176Restructured
      loans
            $
            539
            
            $
            -
            
            $
            -Average
      Recorded Net Investment in Nonperforming Loans
            $
            15,325
            
            $
            3,509
            
            $
            2,438Interest
      Income Recognized for Cash Payments
            
            None
            
            
            None
            
            
            NoneInterest
      Income Foregone on non-accrual loans
            $
            4, 110
            
            $
            1,974
            
            $
            898Total
      Loans Past-Due Ninety Daysor
      More and Still Accruing
            $
            -
            
            $
            140
            
            $
            -





In addition to loans disclosed above as
past due, nonaccrual and restructured as of December 31, 2007, management also
identified further weaknesses in $6.3 million of already classified loans.
Estimated potential losses from these potential credit weaknesses have been
provided for in determining the allowance for loan losses at December 31,
2007.


NOTE
D – SERVICING ASSETS AND INTEREST-ONLY STRIPS RECEIVABLE





At
December 31, 2007, we were servicing approximately $374.4 million of the
guaranteed portion of 7(a) loans previously sold with a weighted-average
servicing and I/O rate of 1.69%. At December 31, 2006, we were servicing
approximately $399.9 million of the guaranteed portion of 7(a) loans previously
sold with a weighted-average servicing and I/O rate of 2.01%. At December 31,
2005, we were servicing approximately $403.3 million of the guaranteed portion
of 7(a) loans previously sold with a weighted-average servicing and I/O rate of
2.46%. The cash collected from servicing is used to cover the operating expenses
of servicing the portfolio. Adequate servicing compensation, in accordance with
industry standards, is 40 basis points of the principal balance sold. A summary
of the changes in the related servicing assets and interest-only strips
receivable for the years ending December 31, 2007, 2006, and 2005, are as
follows:


67


Servicing
      AssetsDecember
      31, 2007
            
            December
      31, 2006
            
            December
      31, 2005(dollars
      in thousands)Balance
      at Beginning of Period
            $
            8,288
            
            $
            8,169
            
            $
            7,586Increase
      from Loan Sales
            
            1,557
            
            
            2,378
            
            
            2,598Amortization
      Charged to Income
            
            -
            
            
            (2,259)
            
            
            (2,015)Fair
      Market value adjustment
            
            (4,495)
            
            
            -
            
            
            -Balance
      at End of Period
            $
            5,350
            
            $
            8,288
            
            $
            8,169Interest-Only
      Strips ReceivableDecember
      31, 2007
            
            December
      31, 2006
            
            December
      31, 2005(dollars
      in thousands)Balance
      at Beginning of Period
            $
            13,215
            
            $
            22,068
            
            $
            24,680Increase
      from Loan Sales
            
            69
            
            
            1,377
            
            
            2,160Amortization
      Charged to Income
            
            -
            
            
            (9,228)
            
            
            (5,478)Fair
      Market value adjustment
            
            (6,685)
            
            
            (1,002)
            
            
            706Balance
      at End of Period
            $
            6,599
            
            $
            13,215
            
            $
            22,068





At
December 31, 2006, we had an unrealized loss of $296 thousand, which decreased
the I/O strip receivable to $13.2 million. At December 31, 2005, we had an
unrealized gain of $706 thousand, which increased the I/O strip receivable to
$22.1 million. The change in fair value of $1.0 million for 2006 was caused
primarily by changes in the prepayment speed assumptions used in the valuation.
As discussed in Note A, all fair value adjustments are recognized through income
in 2007.





The
servicing calculations contain certain assumptions such as expected life of the
loan and the discount rate used to compute the present value of future cash
flows. The exposure of the loan life assumption is if loans prepay faster than
expected. The exposure to the discount rate assumption is if rates adjust
severely and permanently. Such exposure can


cause a
decrease in servicing income. With the assistance of quarterly external
appraisals, we record the I/O Strips at fair value. The term of the underlying
financial assets is predominately greater than 21 years. The table below
summarizes the constant prepayment rates (“CPR”) for national SBA pools for each
year following the date of origination based on their maturities at December 31,
2007 and 2006.





SBA
      Pools - Constant Prepayment RatesVariable
      Rate PoolsDecember
      31,2007
            
            2006Issue
      Date
            <
      8 Yr Life CPR
            8-10
      Yr Life CPR
            10-13
      Yr Life CPR
            13-16
      Yr Life CPR
            16-20
      Yr Life CPR
            >
      20 Yr Life CPR
            
            <
      8 Yr Life CPR
            8-11
      Yr Life CPR
            11-16
      Yr Life CPR
            16-21
      Yr Life CPR
            >
      21 Yr Life CPRYear
      1
            8.69
            7.79
            7.24
            5.20
            7.94
            6.76
            
            8.35
            6.01
            5.71
            4.29
            4.55Year
      2
            17.31
            16.35
            14.58
            12.79
            13.96
            13.27
            
            14.42
            11.66
            10.34
            12.65
            10.05Year
      3
            21.53
            20.55
            18.99
            17.55
            18.25
            18.38
            
            18.53
            16.70
            15.68
            16.81
            17.62Year
      4
            22.13
            21.26
            20.91
            19.82
            20.98
            22.20
            
            18.91
            17.70
            18.99
            19.99
            21.78Year
      5
            19.88
            19.44
            20.77
            20.02
            22.33
            24.83
            
            16.61
            16.17
            18.91
            20.00
            21.27Year
      6
            15.65
            16.03
            19.05
            18.57
            22.48
            26.41
            
            14.75
            16.20
            18.17
            17.68
            20.60Year
      7
            10.69
            12.04
            16.20
            15.92
            21.61
            27.03
            
            11.98
            14.28
            18.08
            18.96
            19.02Year
      8
            6.10
            8.50
            12.72
            12.51
            19.92
            26.82
            
            7.20
            11.03
            13.05
            14.68
            19.30Year
      9
            0.00
            6.33
            9.09
            8.80
            17.57
            25.88
            
            3.70
            9.13
            12.83
            19.47
            19.30Year
      10
            0.00
            5.93
            5.78
            5.25
            14.80
            24.35
            
            1.40
            5.20
            12.65
            14.25
            20.45Year
      11+
            0.00
            0.00
            3.12
            1.61
            7.84
            17.93
            
            0.00
            2.30
            11.90
            9.90
            22.20





The value
of the servicing assets would decrease $725 thousand if prepayment speeds
increased 10% and the value of the servicing asset would decrease $1.3 million
if prepayment speeds increased 20%.





The
expected overall average life of the servicing portfolio is 3.72 years. The
following schedule displays the weighted-average discount rates for each SBA
pool after applying the CPRs identified above and our estimated discount rates
for each SBA pool at December 31, 2007 and 2006 based on assessing each
component.


68





December
      31,2007
            
            2006Original
              Maturity
            Disc
      Rate
            
            Original
              Maturity
            Disc
      Rate<
      8
            Years
            13.24%
            
            <
      8
            Years
            8.94%8-10
            Years
            13.78%
            
            8-11
            Years
            8.84%10-13
            Years
            14.07%
            
            11-16
            Years
            8.77%13-16
            Years
            14.07%
            
            16-21
            Years
            8.72%16-20
            Years
            13.25%
            
            >
      21
            Years
            8.73%>
      20
            Years
            12.98%





The
servicing assets value would decrease $275 thousand if the discount rate
increased 1% and the servicing asset value would decrease $538 thousand if the
discount rate increased 2%. The amount of interest retained on the sold portion
of the SBA 7(a) loans does not change even though most of the underlying loans
are variable rate. Since the retained interest is fixed, changes in interest
rates impact the value. Therefore, when rates rise, the value declines and when
rates decline the value increases.




NOTE
E - PREMISES AND EQUIPMENT





A summary
of premises and equipment as of December 31, 2007 and 2006 follows:





2007
            
            2006(dollars
      in thousands)Land
            $
            500
            
            $
            500Buildings
      and Leasehold Improvements
            
            2,603
            
            
            2,294Autos
            
            1,536
            
            
            1,560Furniture,
      Fixtures, and Equipment
            
            6,906
            
            
            5,96011,545
            
            
            10,314Accumulated
      Depreciation and Amortization
            
            (6,274)
            
            
            (4,822)$
            5,271
            
            $
            5,492





Depreciation
and amortization expense for premises and equipment was $1.6 million in 2007,
$1.5 million in 2006, and $1.1 million in 2005.





We have
entered into several leases for our branches and loan production offices which
expire at various dates through 2014. These leases include provisions for
periodic rent increases as well as payment by the lessee of certain operating
expenses. Rental expense relating to these leases was $2.1 million in 2007, $1.9
million in 2006, and $1.5 million in 2005. The approximate future minimum annual
payments for these leases by year are as follows:




Year
            
            (dollars
      in thousands)2008
            $
            1,8392009
            
            1,2702010
            
            8942011
            
            5442012
            
            201Thereafter
            
            216$
            4,964





The
minimum rental payment shown above is given for the existing lease obligations
and is not a forecast of future rental expense.


69





NOTE
F - DEPOSITS





At
December 31, 2007 the scheduled maturities of time deposits are as
follows:





Year
            (dollars
      in thousands)2008
            $
            849,6392009
            
            2,5892010
            
            1102011
            
            537$
            852,875





Our five
largest depositors had approximately $75.4 million and $35.5 million on deposit
(excluding brokered deposits) at December 31, 2007 and 2006, respectively.
Brokered deposits were $88.2 and $47.2 million at December 31, 2007 and 2006,
respectively.





NOTE
G - FHLB ADVANCES AND OTHER BORROWINGS





At
December 31, 2007 and 2006, there were no borrowings from the Federal Home Loan
Bank (“FHLB”). We are required to pledge a certain amount of loans with the FHLB
for collateralization purposes. As of December 31, 2007, loans with an
outstanding balance of $124.3 million were pledged for an aggregate borrowing
line of $81.1 million. As of December 31, 2006, loans with outstanding balances
of $112.8 million were pledged for an aggregate borrowing line of $73.8
million.





We use
FHLB borrowings to fund loan demand and to manage liquidity in light of deposit
flows. Our borrowing capacity can be used to borrow under various FHLB loan
programs, including adjustable and fixed-rate financing, for periods ranging
from one day to 30 years, with a variety of interest rate structures available.
The borrowing capacity has no commitment fees or cost, requires minimum levels
of investment in FHLB stock (we receive dividend income on our investment in
FHLB stock), can be withdrawn by the FHLB if there is any significant change in
our financial or operating condition, and is conditional upon our compliance
with certain agreements covering advances, collateral maintenance, eligibility
and documentation.





We
maintain federal funds lines of credit with three financial institutions in the
aggregate amount of $58.0 million as of December 31, 2007. As of December 31,
2007 and 2006, no amounts were outstanding under these
arrangements.


NOTE
H - JUNIOR SUBORDINATED DEBT





Pursuant
to rulings of the Federal Reserve Board, bank holding companies are permitted to
issue long-term subordinated debt instruments that will, subject to certain
conditions, qualify as and, therefore, augment capital for regulatory purposes.
The Subordinated Debentures are subordinated to all of our existing and future
borrowings. The
Company’s Subordinated Debentures can be redeemed at par value approximately
five years after the date of issuance.  The Company has the ability to
defer interest payments on each of the subordinated debentures from time to time
for a period not to exceed five consecutive years.  During the period
of deferral, there are restrictions on the Company’s ability to pay dividends.




The table
below summarizes the terms of each issuance of our junior subordinated debt
securities at December 31, 2007 and 2006.




Series
            2007
            
            2006
            
            Date Issued
            
            Rate
      Adjustor
            
            Effective
      Rate
            
            Maturity
      Date(dollars
      in thousand)Temecula
      Valley Statutory Trust I
            $
            -
            
            $
            7,217
            
            June
      2002
            
            3-month
      LIBOR +3.45%
            
            -
            
            2032Temecula
      Valley Statutory Trust II
            
            5,155
            
            
            5,155
            
            September
      2003
            
            3-month
      LIBOR +2.95%
            
            8.64%
            
            2033Temecula
      Valley Statutory Trust III
            
            8,248
            
            
            8,248
            
            September
      2004
            
            3-month
      LIBOR +2.20%
            
            7.13%
            
            2034Temecula
      Valley Statutory Trust IV
            
            8,248
            
            
            8,248
            
            September
      2005
            
            3-month
      LIBOR +1.40%
            
            6.39%
            
            2035Temecula
      Valley Statutory Trust V
            
            12,372
            
            
            12,372
            
            September
      2006
            
            3-month
      LIBOR +1.60%
            
            6.43%
            
            2036Total
            $
            34,023
            
            $
            41,240





70


We also
purchased a 3% minority interest in Temecula Valley Statutory Trusts II, III,
IV, and V. The balance of the equity of Temecula Valley Statutory Trusts II,
III, IV, and V is comprised of mandatorily redeemable preferred securities. In
accordance with FASB Interpretation (“FIN”) No. 46, “Consolidation of Variable Interest
Entities, an interpretation of ARB No. 51”, we do not consolidate
Temecula Valley Statutory Trusts II, III, IV, and V into our financial
statements. Prior to the issuance of FIN No. 46, bank holding companies
typically consolidated these entities. As of December 31, 2007, 2006, and 2005
we have included the net junior subordinated debt in our capital for regulatory
capital purposes.





On June
26, 2007, we redeemed $7.2 million of junior subordinated debt of Temecula
Valley Statutory Trust I. Proceeds from our common stock offering in November
2006 were used to redeem the debt. The debt had a rate of 3-month LIBOR plus
3.45%.





NOTE
I – EMPLOYEE BENEFITS





During
2000, we adopted a retirement savings plan for the benefit of our employees.
Contributions to the plan are determined annually by our Board of Directors. The
expense for this plan was $614 thousand in 2007, $486 thousand in 2006, and $395
thousand in 2005.





We have
entered into retirement benefit agreements with certain officers providing for
future benefits aggregating approximately $22.4 million, payable in equal annual
installments, ranging from ten years to a lifetime benefit, from the retirement
dates of each participating officer. The estimated future benefits to be paid
are being accrued over the period from the effective date of the agreements
until the end of the contractual benefit or death of the executive. The accrued
expense was $1.5 million, $654 thousand, and $723 thousand, for the years ended
December 31, 2007, 2006, and 2005, respectively. As of December 31, 2007 and
2006, $4.6 million and $3.3 million has been accrued in conjunction with these
agreements. Amounts paid under these agreements totaled $400 thousand in 2007
and $215 thousand in 2006. We are the beneficiary under split dollar agreements
of life insurance policies that have been purchased and the net tax free
earnings are used as the method of financing the benefits under the
agreements.





On June
28, 2006, our Board adopted the Executive Nonqualified Excess Plan ("Executive
Nonqualified Plan") and related documents. The Executive Nonqualified Plan is an
unfunded, nonqualified deferred compensation plan intended to comply with the
requirements of Section 409A of the Internal Revenue Code and regulations
promulgated thereunder, and will apply to amounts deferred after January 1, 2005
under the Executive Nonqualified Plan. The purpose of the Executive Nonqualified
Plan is to encourage selected key managerial employees to maintain their
employment with us by allowing them to defer compensation. The key managerial
employees eligible to participate in the Executive Nonqualified Plan are
determined at the sole discretion of our Board. The plan provides for
discretionary matching contributions. We have not approved any
contributions.





On June
28, 2006, our Board approved the adoption of the Employee Stock Ownership Plan
(“ESOP”) for the benefit of eligible employees and their beneficiaries. The ESOP
is intended to constitute a stock bonus employee stock ownership plan within the
meaning of Sections 4975(e)(7) and 407(d)(6) of the Employee Retirement Income
Security Act of 1974. The amount to be contributed to the ESOP by our bank will
be determined by our Board with such contributions principally invested in our
stock. Contributions will be at the discretion of our Board. The employee
benefit expense will be accrued monthly and annually transferred to the ESOP
upon approval of our Board. Contributions to the ESOP plan were $150 thousand
for each of the years ended December 31, 2007 and 2006. Currently, the ESOP is
non-leveraged. As of December 31, 2007, the ESOP owns 19,373 shares of common
stock, of


which
7,038 shares were acquired in the private placement stock offering in November
2006. Following is a brief description of the plan.


·
            To
      be eligible, an employee must:


1.    be
      employed on December 31 of a year


2.    be
      at least 21 years old


3.    complete
      one year of continuous service with our bank (at least 1,000
      hours)


·
            Eligible
      employees automatically become participants in the
  ESOP


·
            Eligible
      employees may receive distributions from the trustee of the ESOP upon
      termination of employment


·
            Vesting
      is over 6 years as follows:




71


Years
      of Service
            Vested
      PercentageLess
      than 2 years
            0%2
      years
            20%3
      years
            40%4
      years
            60%5
      years
            80%6
      or more years
            100%





NOTE
J - INCOME TAXES





The
provision for income taxes included in the statements of income as of the years
ended December 31 consist of the following:


December
      31,2007
            
            2006
            
            2005Current:
            (dollars
      in thousands)Federal
            $
            11,122
            
            $
            10,917
            
            $
            8,686State
            
            3,198
            
            
            3,060
            
            
            2,87014,320
            
            
            13,977
            
            
            11,556Deferred
            
            (3,943)
            
            
            (2,314)
            
            
            (1,670)$
            10,377
            
            $
            11,663
            
            $
            9,886





Deferred
taxes are a result of differences between income tax accounting and generally
accepted accounting principles with respect to income and expense recognition.
Our principal timing differences are from loan loss provision accounting,
deferred compensation plans, and depreciation differences. The provision for
income taxes varies from the federal statutory rate as follows for the years
ended December 31 2007, 2006, and 2005:





December
      31,2007
            
            2006
            
            2005Amount
            
            Percent
      of Pretax Income
            
            
            Amount
            
            Percent
      of Pretax Income
            
            
            Amount
            
            Percent
      of Pretax Income(dollars
      in thousands)Federal
      Tax Rate
            $
            8,930
            
            35.0%
            
            $
            10,004
            
            35.0%
            
            $
            8,344
            
            35.0%State
      Income Taxes, Net of Federal Income Tax Benefit
            
            1,274
            
            5.0%
            
            
            1,619
            
            5.6%
            
            
            1,656
            
            7.0%Income
      from Cash Surrender Value of Life Insurance
            
            (349)
            
            (1.4%)
            
            
            (261)
            
            (0.9%)
            
            
            (177)
            
            (0.7%)Meals
      & Entertainment
            
            67
            
            0.3%
            
            
            73
            
            0.3%
            
            
            53
            
            0.2%Incentive
      Stock Option Expense
            
            240
            
            0.9%
            
            
            265
            
            0.9%
            
            
            21
            
            0.1%Other
      Items, Net
            
            215
            
            0.9%
            
            
            (37)
            
            (0.1%)
            
            
            (11)
            
            (0.1%)Total
            $
            10,377
            
            40.7%
            
            $
            11,663
            
            40.8%
            
            $
            9,886
            
            41.5%





The
following is a summary of the components of the net deferred tax asset accounts
recognized in the accompanying statements of financial condition:




72





December
      31,2007
            
            2006Net
      Deferred Tax Assets
            (dollars
      in thousands)Allowance
      for Loan Losses
            $
            6,737
            
            $
            5,175Deferred
      Compensation Plans
            
            2,526
            
            
            1,675NQ
      Stock Option Expense
            
            201
            
            
            150State
      Taxes
            
            1,007
            
            
            974Reserve
      for Undisbursed Loans
            
            275
            
            
            8Non-accrual
      Interest
            
            1,264
            
            
            492Unrealized
      Loss on I/O Strip Receivable
            
            -
            
            
            125Depreciation
            
            441
            
            
            -Other
      Assets
            
            -
            
            
            20512,451
            
            
            8,804Deferred
      Tax Liabilities:Depreciation
      Differences
            
            -
            
            
            (74)Other
      Liabilities
            
            (153)
            
            
            (250)(153)
            
            
            (324)Net
      Deferred Tax Assets
            $
            12,298
            
            $
            8,480








At December 31, 2007 and 2006, there
was no valuation allowance recorded against the net deferred tax
asset.




The
Company is subject to U.S federal income tax as well as income tax of twelve
states, of which, the primary tax jurisdiction is the state of California. The
Company is no longer subject to examination by the Internal Revenue Service for
years before 2003 and for examination from the taxing authorities of the state
of California for years before 2002.


NOTE
K - EARNINGS PER SHARE (EPS)





The
following is a reconciliation of net income and shares outstanding to the income
and number of shares used to compute EPS as of the years ended December 31,
2007, 2006, and 2005:





December
      31,2007
            
            
            2006
            
            2005Income
            Shares
            
            Per
      Share Amount
            
            
            Income
            Shares
            
            Per
      Share Amount
            
            
            Income
            Shares
            
            Per
      Share Amount(dollars
      and shares in thousands, except per share amount)Net
      Income as Reported
            $
            15,138
            
            
            
            
            $
            16,920
            
            
            
            
            $
            13,953Weighted
      Average Shares
              Outstanding
      During the Year
            
            
            10,411
            
            
            
            
            
            9,235
            
            
            
            
            
            8,846Used
      in Basic EPS
            
            15,138
            10,411
            $
            1.45
            
            
            16,920
            9,235
            $
            1.83
            
            
            13,953
            8,846
            $
            1.58Dilutive
      Effect of Stock
              Options
      and Warrants
            
            
            356
            
            (0.04)
            
            
            
            563
            
            (0.10)
            
            
            
            743
            
            (0.12)Used
      in Dilutive EPS
            $
            15,138
            10,767
            $
            1.41
            
            $
            16,920
            9,798
            $
            1.73
            
            $
            13,953
            9,589
            $
            1.46





Stock
options for 175 thousand, 55 thousand, and 51 thousand shares of common stock
were not considered in computing diluted earnings per common share for 2007,
2006, and 2005, respectively, because they were anitdilutive.





NOTE
L - STOCK OPTION PLAN





At
December 31, 2007, we have three fixed option plans under which 4,000,000 shares
of our holding company’s common stock may be issued. As of December 31, 2007,
there were 180,884 shares available for grant under these plans. Following is a
brief description of each plan.





·
            An
      incentive stock option plan for officers and employees. Under this plan we
      may grant options for up to 1,800,000 shares of common stock at 100% of
      the fair market value at the date the options are
  granted.


·
            A
      nonqualified stock option plan for directors. Under this plan, we may
      grant options for up to 1,500,000 shares of common stock at 85% or greater
      of the fair market value at the date the options are
    granted.


·
            An
      incentive/nonqualified stock option plan for directors, officers and
      employees. Under this plan we may grant options for up to 700,000 shares
      of common stock at 100% of the fair market value for incentive stock
      options and 85% or greater of the fair market value for non qualified
      stock options as of the grant date.





Options
have a maximum ten-year life from the grant date and, with respect to incentive
options, generally vest and become exercisable over three years after the date
of grant. Non qualified options generally vest immediately.


73


The
grant-date fair value of employee share options and similar instruments is
estimated using option-pricing models adjusted for unique characteristics of
those instruments (unless observable market prices for the same or similar
instruments are available). If an equity award is modified after the grant date,
incremental compensation cost will be recognized in an amount equal to the
excess of the fair value of the modified award over the fair value of the
original award immediately before the modification.





The
weighted-average grant-date fair value of options granted during 2007 was $6.10.
The weighted-average grant-date fair value of options granted during 2006 was
$7.06. The weighted-average grant-date fair value of options granted during 2005
was $5.90. The fair value of each option granted was estimated on the date of
grant using the Black-Scholes option-pricing model with the following
weighted-average assumptions:


December
      31,2007
            
            2006
            
            2005Expected
      life (years)
            4
            
            4
            
            5Risk-free
      interest rate
            4.76%
            
            4.39%
            
            4.36%Weighted
      Average Expected Volatility
            36.72%
            
            29.29%
            
            24.30%Expected
      annual dividends
            none
            
            none
            
            none





The
expected life of the options represents the period of time that options granted
are expected to be outstanding based primarily on the historical exercise
behavior attributable to previous option grants. The risk free interest rate is
based on a rate comparable with the expected life of the option. The expected
volatility is determined based on the historical daily volatility of our stock
price over a period equal to the expected life of the option. A summary of stock
option activity as of December 31, 2007, is presented below:


Stock
      Options
            
            Weighted
      Average Exercise Price
            
            Aggregate
      Intrinsic Value
            
            Weighted
      Average Remaining Contractual LifeOutstanding
      as of 01/01/2007
            1,415,398
            
            $
            9.38Granted
            76,700
            
            $
            17.09Exercised
            (245,351)
            
            $
            3.76Forfeited,
      expired or cancelled
            (69,334)
            
            $
            18.76Outstanding
      as of 12/31/2007
            1,177,413
            
            $
            10.49
            
            $
            4,556,495
            
            2.98Vested
      or expected to vest
            1,168,085
            
            $
            10.45
            
            $
            4,556,495
            
            2.98Shares
      exercisable as of 12/31/2007
            990,856
            
            $
            8.89
            
            $
            4,556,495
            
            2.98





Tax
benefits recognized in income tax expense relative to the vesting of
nonqualified stock options were $51 thousand and $150 thousand in 2007 and 2006,
respectively. No tax benefit is recognized for incentive stock options. SFAS No.
123R requires that an estimate of forfeitures be made when the awards are
granted and thereafter updated if information becomes available indicating that
actual forfeitures will differ. Based on historical information, the average
annual forfeiture rate used for awards granted during 2007 was 3.18%. The total
intrinsic value of options exercised during 2007, 2006, and 2005 was $3.5
million, $5.2 million, and $1.9 million, respectively. The intrinsic value
equals the difference between the exercise price and the market price on the
date of measurement. Options outstanding at December 31, 2007, that subsequently
vest will result in net compensation costs of approximately $451 thousand in
2008, $208 thousand in 2009, and $88 thousand in 2010.




NOTE
M – LOAN COMMITMENTS AND RELATED FINANCIAL INSTRUMENTS





In the
normal course of business, we enter into financial commitments to meet the
financing needs of our customers. These financial commitments include
commitments to extend credit and standby letters of credit. Those instruments
involve, to varying degrees, elements of credit and interest rate risk not
recognized in the statement of financial condition.





Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Standby letters of
credit are conditional commitments to guarantee the performance of our customer
to a third party. Since many of the commitments and standby letters of credit
are expected to expire without being


74


drawn
upon, the total amounts do not necessarily represent future cash requirements.
We evaluate each customer's credit worthiness on a case-by-case basis. The
amount of collateral obtained, if deemed necessary by us, is based on our credit
evaluation of the customer.





Our
exposure to loan loss in the event of nonperformance on commitments to extend
credit and standby letters of credit is represented by the contractual amount of
those instruments. We use the same credit policies in making commitments as we
do for loans reflected in our financial statements. As of December 31, 2007 and
2006, we had the following outstanding financial commitments whose contractual
amount represents credit risk:





December
      31, 2007
            
            December
      31, 2006Fixed
            
            
            Variable
            
            
            Total
            
            
            Fixed
            
            
            Variable
            
            
            Total(dollars
      in thousands)Commitments
      to Extend Credit
            $
            10,843
            
            $
            437,994
            
            $
            448,837
            
            $
            3,331
            
            $
            395,023
            
            $
            398,354Letters
      of Credit
            
            -
            
            
            11,447
            
            
            11,447
            
            
            -
            
            
            3,514
            
            
            3,514Loan
      Commitments Outstanding
            $
            10,843
            
            $
            449,441
            
            $
            460,284
            
            $
            3,331
            
            $
            398,537
            
            $
            401,868





The fixed
rate loan commitments have interest rates ranging from 3.49% to 21.00% as of
December 31, 2007 and 6.12% to 11.25% as of December 31, 2006.





We are
involved in various litigations which have arisen in the ordinary course of our
business. In the opinion of our management, the disposition of such pending
litigation will not have a material effect on our financial
statements.





NOTE
N - FAIR VALUE OF FINANCIAL INSTRUMENTS





The fair
value of a financial instrument is the amount at which the asset or obligation
could be exchanged in a current transaction between willing parties, other than
in a forced or liquidation sale. Fair value estimates are made at a specific
point in time based on relevant market information and information about the
financial instrument. These estimates do not reflect any premium or discount
that could result from offering for sale at one time the entire holdings of a
particular financial instrument. Because no market value exists for a
significant portion of the financial instruments, fair value estimates are based
on judgments regarding future expected loss experience, current economic
conditions, risk characteristics of various financial instruments, and other
factors. These estimates are subjective in nature, involve uncertainties and
matters of judgment and, therefore, cannot be determined with precision. Changes
in assumptions could significantly affect the estimates.





Fair
value estimates are based on financial instruments both on and off the balance
sheet without attempting to estimate the value of anticipated future business
and the value of assets and liabilities that are not considered financial
instruments. Additionally, tax consequences related to the realization of the
unrealized gains and losses can have a potential effect on fair value estimates
and have not been considered in many of the estimates. The following methods and
assumptions were used to estimate the fair value of significant financial
instruments:





Financial
Assets





The
carrying amounts of cash, interest-bearing deposits with other financial
institutions, federal funds sold, FRB and FHLB stock, and accrued interest are
considered to approximate fair value. The fair value of loans are estimated
using a combination of techniques, including discounting estimated future cash
flows and quoted market prices of similar instruments where available. Security
fair values are based on market prices or dealer quotes.





Servicing Assets and
Interest-Only Strips Receivable





Fair
value is based on an independent appraisal using a method that discounts
estimated future cash flows from the servicing assets using discount rates that
approximate current market rates over the expected lives of the loans being
serviced.





Financial
Liabilities





The
carrying amounts of deposit liabilities payable on demand, FHLB advances,
accrued interest, and junior subordinated debt securities are considered to
approximate fair value. For fixed maturity deposits, fair value is estimated by
discounting estimated future cash flows using currently offered rates for
deposits of similar remaining maturities.


75


Off-Balance Sheet Financial
Instruments





The fair
value of commitments to extend credit and standby letters of credit is estimated
using the fees currently charged to enter into similar agreements. The fair
value of these financial instruments is not material.





The
estimated fair value of financial instruments at December 31, 2007, and 2006 is
summarized as follows:





2007
            
            2006Financial
      Assets:
            
            Carrying
      Value
            
            Fair
      Value
            
            
            Carrying
      Value
            
            Fair
      Value(dollars
      in thousands)Cash
      and Due From Banks
            $
            13,210
            
            $
            13,210
            
            $
            15,190
            
            $
            15,190Interest-bearing
      deposits with other Financial Institutions
            1,000
            
            
            1,000
            
            
            99
            
            
            99Federal
      Funds Sold
            
            4,220
            
            
            4,220
            
            
            18,180
            
            
            18,180FNMA
      MBS (held-to-maturity)
            
            2,981
            
            
            3,046
            
            
            1,019
            
            
            1,029Loans
      Held-for-Sale
            
            207,391
            
            
            207,391
            
            
            173,120
            
            
            173,120Loans,
      net
            
            1,014,304
            
            
            1,013,102
            
            
            957,051
            
            
            952,565Federal
      Reserve and FHLB Stock
            
            2,905
            
            
            2,905
            
            
            1,996
            
            
            1,996I/O
      Strips Receivable and Servicing Assets
            
            11,949
            
            
            11,949
            
            
            21,503
            
            
            21,503Accrued
      Interest Receivable
            
            6,827
            
            
            6,827
            
            
            6,155
            
            
            6,155Financial
      Liabilities:Deposits
            
            1,161,071
            
            
            1,161,175
            
            
            1,081,501
            
            
            1,081,598FHLB
      Advances
            
            0
            
            
            0
            
            
            0
            
            
            0Junior
      Subordinated Debt
            
            34,023
            
            
            34,023
            
            
            41,240
            
            
            41,240Accrued
      Interest Payable
            
            2,329
            
            
            2,329
            
            
            2,094
            
            
            2,094


NOTE
O - REGULATORY MATTERS





Our
company and our bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on our bank's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, our bank
must meet specific capital guidelines that involve quantitative measures of our
bank's assets, liabilities, and certain off-balance sheet items as calculated
under regulatory accounting practices. Our bank's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors. For capital adequacy purposes,
our company and our bank must maintain total capital to risk-weighted assets and
Tier 1 capital to risk-weighted assets of 8.0% and 4.0%,
respectively.





Quantitative
measures established by regulation to ensure capital adequacy require our
company and our bank to maintain minimum amounts and ratios (set forth in the
tables below) of total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average
assets (as defined). Management believes, as of December 31, 2007, that both our
company and our bank have met all capital adequacy requirements to which they
are subject. The following table sets forth our company’s actual capital amounts
and ratios:


Amount
      of Capital RequiredTemecula
      Valley Bancorp
            
            
            
            
            
            For
      Capital Adequacy PurposesAmount
            
            Ratio
            
            Amount
            
            RatioAs
      of December 31, 2007:Total
      Risk-Based Capital (to Risk-Weighted Assets)
            $
            157,101
            
            10.80%
            
            $
            116,380
            
            8.00%Tier
      1 Risk-Based Capital (to Risk-Weighted Assets)
            $
            140,424
            
            9.65%
            
            $
            58,190
            
            4.00%Tier
      1 Leverage Ratio (to Average Assets)
            $
            140,424
            
            10.63%
            
            $
            52,844
            
            4.00%As
      of December 31, 2006:Total
      Risk-Based Capital (to Risk-Weighted Assets)
            $
            154,976
            
            11.90%
            
            $
            104,195
            
            8.00%Tier
      1 Risk-Based Capital (to Risk-Weighted Assets)
            $
            136,579
            
            10.49%
            
            $
            52,097
            
            4.00%Tier
      1 Leverage Ratio (to Average Assets)
            $
            136,579
            
            11.42%
            
            $
            47,881
            
            4.00%





76


As of
December 31, 2007, the most recent notification from the regulators categorized
our bank as well capitalized under the regulatory framework for prompt
corrective action (there are no conditions or events since that notification
that management believes have changed our bank's category). To be categorized as
well capitalized, our bank must maintain minimum ratios as set forth in the
table below. The following table sets forth our bank's actual capital amounts
and ratios:





Amount
      of Capital RequiredTemecula
      Valley Bank
            
            
            
            
            
            For
      Capital Adequacy Purposes
            
            To
      Be Well Capitalized Under Prompt Corrective ProvisionsAmount
            
            Ratio
            
            Amount
            
            Ratio
            
            Amount
            
            RatioAs
      of December 31, 2007:Total
      Risk-Based Capital (to Risk-Weighted Assets)
            $
            154,912
            
            10.66%
            
            $
            116,290
            
            8.00%
            
            $
            145,362
            
            10.00%Tier
      1 Risk-Based Capital (to Risk-Weighted Assets)
            $
            138,235
            
            9.51%
            
            $
            58,145
            
            4.00%
            
            $
            87,217
            
            6.00%Tier
      1 Leverage Ratio (to Average Assets)
            $
            138,235
            
            10.48%
            
            $
            52,805
            
            4.00%
            
            $
            66,006
            
            5.00%As
      of December 31, 2006:Total
      Risk-Based Capital (to Risk-Weighted Assets)
            $
            145,702
            
            11.20%
            
            $
            104,090
            
            8.00%
            
            $
            130,113
            
            10.00%Tier
      1 Risk-Based Capital (to Risk-Weighted Assets)
            $
            133,160
            
            10.23%
            
            $
            52,045
            
            4.00%
            
            $
            78,068
            
            6.00%Tier
      1 Leverage Ratio (to Average Assets)
            $
            133,160
            
            11.16%
            
            $
            47,773
            
            4.00%
            
            $
            59,716
            
            5.00%





Our bank
is restricted as to the amount of dividends that can be paid to our holding
company. Dividends declared by banks that exceed the net income (as defined) for
the current year plus retained net income for the preceding two years must be
approved by the regulators. Our bank may not pay dividends that would result in
its capital levels being reduced below the minimum requirements shown above. As
of December 31, 2007, our bank is authorized to pay $37.5 under these
requirements.


NOTE
P – CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY ONLY





Temecula
Valley Bancorp Inc. operates Temecula Valley Bank. Temecula Valley Bancorp Inc.
commenced operations during 2002. The earnings of the subsidiary are recognized
on the equity method of accounting. Condensed financial statements of our parent
company only are presented below:





CONDENSED
      STATEMENTS OF FINANCIAL CONDITIONYear
      Ended December 31,2007
            
            2006ASSETS:
            (dollars
      in thousands)Cash
            $
            2,616
            
            $
            9,322Investment
      in Temecula Valley Statutory Trust I
            
            -
            
            
            217Investment
      in Temecula Valley Statutory Trust II
            
            155
            
            
            155Investment
      in Temecula Valley Statutory Trust III
            
            248
            
            
            248Investment
      in Temecula Valley Statutory Trust IV
            
            248
            
            
            248Investment
      in Temecula Valley Statutory Trust V
            
            372
            
            
            372Investment
      in Temecula Valley Bank
            
            138,771
            
            
            133,989Other
      Assets
            
            101
            
            
            68$
            142,511
            
            $
            144,619LIABILITIES
      AND SHAREHOLDERS' EQUITY:Other
      Liabilities
            $
            529
            
            $
            116Junior
      Subordinated Debt
            
            34,023
            
            
            41,240Shareholders'
      Equity
            
            107,959
            
            
            103,263$
            142,511
            
            $
            144,619


77





CONDENSED
      STATEMENTS OF INCOMEYear
      Ended December 31,2007
            
            
            2006
            
            
            2005INCOME:
            (dollars
      in thousands)Dividends
      from Subsidiary Bank
            $
            13,000
            
            $
            -
            
            $
            -Cash
      Dividends from Statutory Trusts
            
            85
            
            
            73
            
            
            41TOTAL
      INCOME
            
            13,085
            
            
            73
            
            
            41EXPENSES:Interest
      on Junior Subordinated Debt
            
            2,847
            
            
            2,423
            
            
            1,450Other
            
            407
            
            
            288
            
            
            513Income
      Tax Benefit
            
            (1,333)
            
            
            (1,109)
            
            
            (808)1,921
            
            
            1,602
            
            
            1,155INCOME
      (LOSS) BEFORE EQUITY IN UNDISTRIBUTED INCOME OF
      SUBSIDIARY
            
            11,164
            
            
            (1,529)
            
            
            (1,114)EQUITY
      IN UNDISTRIBUTED INCOME OF SUBSIDIARY
            
            3,974
            
            
            18,449
            
            
            15,067NET
      INCOME
            $
            15,138
            
            $
            16,920
            
            $
            13,953CONDENSED
      STATEMENTS OF CASH FLOWS
            
            Year
      Ended December 31,2007
            
            2006
            
            2005CASH
      FLOWS FROM OPERATING ACTIVITIES:
            (dollars
      in thousands)Net
      income
            $
            15,138
            
            $
            16,920
            
            $
            13,953Noncash
      items included in net income:Equity
      in income of Subsidiary
            
            (3,974)
            
            
            (18,449)
            
            
            (15,067)Other
            
            1,317
            
            
            871
            
            
            (8)NET
      CASH PROVIDED BY(USED) IN OPERATING ACTIVITIES
            
            12,481
            
            
            (658)
            
            
            (1,122)CASH
      FLOWS FROM INVESTING ACTIVITIES:Investment
      in Subsidiaries
            
            -
            
            
            (30,700)
            
            
            (7,000)NET
      CASH USED BY INVESTING ACTIVITIES
            
            -
            
            
            (30,700)
            
            
            (7,000)CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds
      from Junior Subordinated Debt Securities
            
            -
            
            
            12,372
            
            
            8,248Retirement
      of Junior Subordinated Debt Securities
            
            (7,217)
            
            
            -
            
            
            -Repurchase
      and retirement of common stock
            
            (12,061)
            
            
            -
            
            
            -Proceeds
      from exercise of stock options
            
            923
            
            
            1,114
            
            
            876Cash
      dividends on common stock
            
            (832)
            
            
            -
            
            
            -Proceeds
      from private placement stock offering, net
            
            -
            
            
            25,137
            
            
            -NET
      CASH PROVIDED BY FINANCING ACTIVITIES
            
            (19,187)
            
            
            38,623
            
            
            9,124NET
      INCREASE IN CASH AND CASH EQUIVALENTS
            
            (6,706)
            
            
            7,265
            
            
            1,002CASH
      AND CASH EQUIVALENTS AT BEGINNING OF YEAR
            
            9,322
            
            
            2,057
            
            
            1,055CASH
      AND CASH EQUIVALENTS AT END OF YEAR
            $
            2,616
            
            $
            9,322
            
            $
            2,057


NOTE
Q – SUBSEQUENT EVENT





On
January 17, 2008, our bank issued 2,213,750 shares of junior subordinated debt
securities in a public offering. Net proceeds of the offering were $20.9
million. The proceeds of the offering will be used to fund the growth to our
bank and possibly to repurchase our common stock.


78


INDEX TO EXHIBITS


The
following documents are included or incorporated by reference in this report on
Form 10-K:


EXHIBIT  NO.2.(i)
              Temecula
      Valley Bank and Temecula Valley Bancorp Amended and Restated Plan of
      Reorganization dated as of April 2, 2002 (included as an exhibit to
      Temecula Valley Bancorp’s Form 8-A12G, filed on June 3, 2002 and
      incorporated herein by reference)2.(ii)
              Agreement
      and Plan of Merger of Temecula Merger Corporation and Temecula Valley
      Bancorp (included as an exhibit to Temecula Valley Bancorp’s Definitive
      Proxy Statement on Schedule 14A, filed November 20, 2003 and incorporated
      herein by reference)3.(i)
              Articles
      of Incorporation of Temecula Valley Bancorp (included as an exhibit to
      Temecula Valley Bancorp’s Definitive Proxy Statement on Schedule 14A,
      filed November 20, 2003 and incorporated herein by
    reference)3.(ii)
              Amended
      and Restated Bylaws of Temecula Valley Bancorp (included as an exhibit to
      Temecula Valley Bancorp’s Form 8-K, filed on June 28, 2007 and
      incorporated herein by reference)4.1
              Common
      Stock Certificate of Temecula Valley Bancorp (included as an exhibit to
      Temecula Valley Bancorp’s Form 10-Q, filed on May 17, 2004 and
      incorporated herein by reference)4.2
              Indenture
      between Temecula Valley Bancorp and Wilmington Trust Company dated January
      17, 2008 *4.3
              Indenture
      between Temecula Valley Bancorp and U S Bank National Association dated
      September 17, 2003 *4.4
              Indenture
      between Temecula Valley Bancorp and Wilmington Trust Company dated
      September 20, 2004 *4.5
              Indenture
      between Temecula Valley Bancorp and Wilmington Trust Company dated
      September 29, 2005 (included as an exhibit to Temecula Valley Bancorp’s
      Form 10-Q, filed on November 14, 2005 and incorporated herein by
      reference)4.6
              Indenture
      between Temecula Valley Bancorp and Wilmington Trust Company dated
      September 27, 2006 (included as an exhibit to Temecula Valley Bancorp’s
      Form 8-K, filed on October 3, 2006 and incorporated herein by
      reference)10.1
              Temecula
      Valley Bank, N.A. Lease Agreement for Main Office (included as an exhibit
      to Temecula Valley Bancorp’s Form 10-K/SB, filed on March 11, 2003 and
      incorporated herein by reference)10.2
              Stephen
      H. Wacknitz Employment Agreement effective May 1, 2007 (included as an
      exhibit to Temecula Valley Bancorp’s Form 10-Q , filed on August 8, 2007
      and incorporated by reference) #10.4
              First
      Amendment dated March 10, 2008 to Donald A. Pitcher Employment Agreement *
      #10.5
              Description
      of executive officer compensation (included with Temecula Valley Bancorp’s
      Form 8-K, filed on December 27, 2006 and incorporated herein by reference)
      #10.6
              401(k)
      (included with Temecula Valley Bancorp’s Form 10 K/SB, filed on April 16,
      2004 and incorporated herein by reference) #10.7
              First
      Amendment dated March 10, 2008 to Frank Basirico, Jr. Employment Agreement
      * #10.8
              Amended
      and Restated Declaration of Trust among Wilmington Trust Company, Temecula
      Valley Bancorp and Administrators dated September 20, 2004
    *10.9
              James
      W. Andrews Employment Agreement dated June 1, 2002 (included in Temecula
      Valley Bancorp’s Form 10-K/SB, filed on April 11, 2003 and incorporated
      herein by reference) #
  79
  10.10
              1996
      Incentive and Non Qualified Stock Option Plan (Employees), as amended by
      that certain First Amendment effective May 15, 2001 and that certain
      Second Amendment effective May 15, 2002 (included in Temecula Valley
      Bancorp's 10-K/SB, filed on April 11, 2003 and iincorporated herein by
      reference)#10.11(a)
              Form
      of ISO Stock Option Agreement for Employee Plan (included in Temecula
      Valley Bancorp’s Form 10-K, filed on March 31, 2005 and incorporated
      herein by reference) #10.11(b)
              Form
      of ISO Stock Option Agreement for Employee Plan with Acceleration
      Provisions (included in Temecula Valley Bancorp’s Form 10-K, filed on
      March 31, 2006 and incorporated herein by reference) #10.11
              1997
      Non Qualified Stock Option Plan (Directors), as amended by that certain
      First Amendment effective May 15, 2001 and that certain Second Amendment
      effective May 15, 2002 (“Director Plan”) (included in Temecula Valley
      Bancorp's 10-K/SB, filed on April 11, 2003 and iincorporated herein by
      reference)#10.12(a)
              Form
      of NSO Stock Option Agreement for Director Plan (included in Temecula
      Valley Bancorp’s Form 10-K, filed on March 31, 2005 and incorporated
      herein by reference) #10.12
              Amended
      and Restated Salary Continuation Agreement between Temecula Valley Bank
      and Stephen H. Wacknitz dated September 30, 2004 (included in Temecula
      Valley Bancorp’s Form 10-Q/A, filed on November 18, 2004 and incororated
      herein by reference)#10.13
              Amended
      and Restated Salary Continuation Agreement between Temecula Valley Bank
      and Luther J. Mohr dated January 28, 2004 (included in Temecula Valley
      Bancorp’s Form 10-Q/A, filed on November 18, 2004 and incorporated herein
      by reference)#10.14
              Temecula
      Valley Bank Employee Stock Ownership Plan effective as of January 1, 2006
      (included in Temecula Valley Bancorp’s Form 10-Q, filed on August 8, 2006
      and incorporated herein by reference) #10.15
              The
      Executive Nonqualified Plan (included in Temecula Valley Bancorp’s Form
      10-Q, filed on August 8, 2006 and incorporated herein by reference)
      #10.16
              Amendment
      to the Temecula Valley Bank Executive Supplemental Compensation Agreement
      between Temecula Valley Bank and Martin Plourd dated December 31,
      2007*#10.17
              Amendment
      to the Split Dollar Agreement between Temecula Valley Bank
      and  Martin Plourd dated December 31, 2007*#10.17(a)
              Temecula
      Valley Bancorp Inc. 2004 Stock Incentive Plan, as amended ("Stock
      Incentive Plan") (included in Temecula Valley Bancorp’s Form 10-Q, filed
      on August 20, 2004 and incorporated herein by reference)
  #10.17(b)
              Form
      of NSO Stock Option Agreement for Stock Incentive Plan (included in
      Temecula Valley Bancorp’s Form 10-K, filed on March 31, 2005 and
      incorporated herein by reference) #10.17(c)
              Form
      of ISO Stock Option Agreement for Stock Incentive Plan (included in
      Temecula Valley Bancorp’s Form 10-K, filed on March 31, 2005 and
      incorporated herein by reference) #10.17(d)
              Form
      of ISO Stock Option Agreement for Stock Incentive Plan with Acceleration
      Provisions (included in Temecula Valley Bancorp’s Form 10-K, filed on
      March 31, 2006 and incorporated herein by reference) #10.18
              Executive
      Deferred Compensation Agreement between Temecula Valley Bank and Stephen
      H. Wacknitz dated September 30, 2004 (included in Temecula Valley
      Bancorp’s Form 10-Q/A, filed on November 18, 2004 and incorporated herein
      by reference)#10.19
              Salary
      Continuation Agreement between Temecula Valley Bank and Stephen H.
      Wacknitz dated January 28, 2004 (included in Temecula Valley Bancorp’s
      Form 10-Q/A, filed on November 18, 2004 and incorporated herein by
      reference)#
  80
  10.20
              Amended
      and Restated Salary Continuation Agreement between Temecula Valley Bank
      and Scott J. Word entered into December 29, 2006 (included in Temecula
      Valley Bancorp’s Form 10-K, filed on March 14, 2007 and incorporated
      herein by reference)#10.21
              Amendment
      to the Executive Supplemental Compensation Agreement between Temecula
      Valley Bank and Jim Andrews dated December 31, 2007*#10.22
              Split
      Dollar Agreement between Temecula Valley Bank and Luther J. Mohr dated
      September 30, 2004 (included in Temecula Valley Bancorp’s Form 10-Q/A,
      filed on November 18, 2004 and incorporated herein by reference)
      #10.22(a)
              First
      Amendment dated December 31, 2005 to Split Dollar Agreement between
      Temecula Valley Bank and Luther J. Mohr dated September 30, 2004 (included
      in Temecula Valley Bancorp’s Form 10-K, filed on March 31, 2006 and
      incorporated herein by reference)#10.23
              Split Dollar Agreement between Temecula Valley Bank and Stephen H.
      Wacknitz dated September 30, 2004, (included in Temecula Valley Bancorp’s
      Form 10-Q/A, filed on November 18, 2004 and incorporated herein by
      reference)#10.23(a)
              Split
      Dollar Agreement between Temecula Valley Bank and Stephen H. Wacknitz
      executed November 2005 with an effective date of August 1, 2005 (included
      in Temecula Valley Bancorp’s Form 10-K, filed on March 31, 2006 and
      incorporated herein by reference)#10.23(b)
              First
      Amendment dated December 31, 2005 of Split Dollar Agreement between
      Temecula Valley Bank and Stephen H. Wacknitz dated September 30, 2004
      (included in Temecula Valley Bancorp’s Form 10-K, filed on March 31, 2006
      and incorporated herein by reference)#10.23(c)
              First
      Amendment dated December 31, 2005 of Split Dollar Agreement between
      Temecula Valley Bank and Stephen H. Wacknitz dated August 1, 2005
      (included in Temecula Valley Bancorp’s Form 10-K, filed on March 31, 2006
      and incorporated herein by reference)#10.24
              Amended
      and Restated Split Dollar Agreement between Temecula Valley Bank and Scott
      J. Word entered into December 29, 2006 (included in Temecula Valley
      Bancorp’s Form 10-K, filed on March 14, 2007 and  incorporated
      herein by reference)#10.25
              Donald
      A. Pitcher Employment Agreement dated December 4, 2006 (included in
      Temecula Valley Bancorp’s Form 8-K, filed on December 5, 2006 and
      incorporated herein by reference) #10.26
              Bonus
      Pool Arrangement/Executive Officer Compensation and Duties Title
      disclosure (included in Temecula Valley Bancorp’s Form 8-K filed on July
      27, 2007 and incorporated herein by reference) #10.27
              Amended
      and Restated Salary Continuation Agreement between Temecula Valley Bank
      and Thomas M. Shepherd entered into December 29, 2006 (included in
      Temecula Valley Bancorp’s Form 10-K, filed on March 31, 2005
      and  incorporated herein by reference)#10.28
              Amended
      and Restated Split Dollar Agreement between Temecula Valley Bank and
      Thomas M. Shepherd entered into December 29, 2006 (included in Temecula
      Valley Bancorp’s Form 10-K, filed on March 14, 2007
      and  incorporated herein by reference)#10.29
              Amended
      and Restated Salary Continuation Agreement between Temecula Valley Bank
      and Donald A. Pitcher entered into December 29, 2006 (included in Temecula
      Valley Bancorp’s Form 10-K, filed on March 14, 2007 and incorporated
      herein by reference)#10.30
              Amended
      and Restated Split Dollar Agreement between Temecula Valley Bank and
      Donald A. Pitcher entered into December 29, 2006 (included in Temecula
      Valley Bancorp’s Form 10-K, filed on March 14, 2007
      and  incorporated herein by reference)#10.31
              William
      H. McGaughey Employment Agreement dated January 4, 2005 (included in
      Temecula Valley Bancorp’s Form 10-K, filed on March 31, 2005 and
      incorporated herein by reference)
#
  81
  10.32
              Salary
      Continuation Agreement between William McGaughey and Temecula Valley Bank
      dated June 1, 2005 (included in Temecula Valley Bancorp’s Form 10-Q, filed
      on August 9, 2005 and incorporated herein by reference)
  #10.33
              Executive
      Officer Compensation disclosure (included in Temecula Valley Bancorp’s
      Form 8-K, filed on February 7, 2006 and incorporated herein by reference)
      #10.34
              Description
      of executive officer compensation and description of Bonus Pool
      Arrangement-Revised and Restated (included in Temecula Valley Bancorp’s
      Form 8-K, filed on March 7, 2006, and incorporated by reference) revising
      Executive Officer Compensation-Revised and Restated (originally filed as
      Exhibit 10.34 on February 7, 2006 to Temecula Valley Bancorp’s Form 8-K
      and incorporated herein by reference)#10.35
              Director
      compensation disclosure filed on December 27, 2006 (included in Temecula
      Valley Bancorp’s Form 8-K, filed on December 27, 2006, and incorporated by
      reference) revising Director Compensation disclosure originally filed
      February 2, 2006 to Temecula Valley Bancorp’s Form 8-K and incorporated
      herein by reference)#10.36
              Executive
      Officer Compensation disclosure (included in Temecula Valley Bancorp’s
      Form 8-K, filed on July 27, 2007 and incorporated herein by reference)
      #10.37
              Executive
      Officer Compensation disclosure (included in Temecula Valley Bancorp’s
      Form 8-K, filed on July 27, 2007 and incorporated herein by reference)
      #10.38
              David
      Bartram Employment Agreement effective November 19, 2007 (included as an
      exhibit to Temecula Valley Bancorp’s Form 8-K, filed on November 21, 2007
      and incorporated herein by reference) #10.39
              Frank
      Basirico, Jr. Employment Agreement dated February 10, 2006 (included in
      Temecula Valley Bancorp’s Form 10-K, filed on March 31, 2006 and
      incorporated herein by reference) #10.40
              Indemnification
      provided to U.S. Stock Transfer dated December 8, 2005 (included in
      Temecula Valley Bancorp’s Form 10-K, filed on March 31, 2006 and
      incorporated herein by reference)10.41
              Indemnification
      provided by Director to Temecula Valley Bancorp dated December 8, 2005,
      (included in Temecula Valley Bancorp’s Form 10-K, filed on March 31, 2006
      and incorporated herein by reference)10.42
              Purchase
      Agreement dated as of September 27, 2006 (included in Temecula Valley
      Bancorp’s Form 8-K, filed on October 3, 2006 and incorporated herein by
      reference)10.43
              Form
      of Registration Rights Agreement dated November 21, 2006 (included in
      Temecula Valley Bancorp’s Form 8-K, filed on November 22, 2006 and
      incorporated herein by reference)10.44
              Forms
      of Subscription Agreement dated November 21, 2006 (included in Temecula
      Valley Bancorp’s Form 8-K, filed on November 22, 2006 and incorporated
      herein by reference)10.45
              Executive
      Supplemental Compensation Agreement between Temecula Valley Bank and James
      W. Andrews entered into December 29, 2006 (included in Temecula Valley
      Bancorp’s Form 10-K, filed on March 14, 2007 and incorporated herein by
      reference)#10.46
              Split
      Dollar Agreement between Temecula Valley Bank and James W. Andrews entered
      into December 29, 2006 (included in Temecula Valley Bancorp’s Form 10-K,
      filed on March 14, 2007 and incorporated herein by reference)
      #10.47
              First
      Amendment dated December 29, 2006 to the Split Dollar Agreement between
      Temecula Valley Bank and William H. McGaughey dated June 1, 2006 (included
      in Temecula Valley Bancorp’s Form 10-K, filed on March 14, 2007 and
      incorporated herein by
reference)#
  82
  10.48
              Executive
      Supplemental Compensation Agreement between Temecula Valley Bank and
      Martin E. Plourd entered into December 29, 2006 (included in Temecula
      Valley Bancorp’s Form 10-K, filed on March 14, 2007 and incorporated
      herein by reference)#10.49
              Split
      Dollar Agreement between Temecula Valley Bank and Martin E. Plourd entered
      into December 29, 2006 (included in Temecula Valley Bancorp’s Form 10-K,
      filed on March 14, 2007 and incorporated herein by reference)
      #10.50
              Executive
      Supplemental Compensation Agreement between Temecula Valley Bank and Frank
      Basirico, Jr. entered into December 29, 2006 (included in Temecula Valley
      Bancorp’s Form 10-K, filed on March 14, 2007 and incorporated herein by
      reference)#10.51
              Split
      Dollar Agreement between Temecula Valley Bank and Frank Basirico, Jr.
      entered into December 29, 2006 (included in Temecula Valley Bancorp’s Form
      10-K, filed on March 14, 2007 and incorporated herein by reference)
      #10.52
              First
      Amendment dated March 10, 2008 to William H. McGaughey Employment
      Agreement* #10.53
              Second
      Amendment dated March 10, 2008 to James W. Andrews Employment Agreement*
      #10.54
              Amended
      and Restated Trust Agreement among Temecula Valley Bancorp, Wilmington
      Trust Company and the Administrative Trustees dated January 17, 2008
      *10.55
              Amended
      and Restated Declaration of Trust among U S Bank National Association,
      Temecula Valley Bancorp and Administrators dated September 17, 2003
      *10.56
              Amended
      and Restated Declaration of Trust among Temecula Valley Bancorp,
      Wilmington Trust Company and the Administrators dated September 25, 2005
      (included in Temecula Valley Bancorp’s Form 10-Q, filed November 4, 2005
      and incorporated herein by reference)10.57
              Amendment
      to the Split Dollar Agreement between Temecula Valley Bank and Scott J.
      Word dated December 31, 2007*#10.58
              Amendment
      to the Salary Continuation Agreement between Temecula Valley Bank and
      Scott J. Word dated December 31, 2007*#10.59
              Amendment
      to the Salary Continuation Agreement between Temecula Valley Bank and
      Donald A. Pitcher dated December 31, 2007*#10.60
              Amendment
      to the Split Dollar Agreement between Temecula Valley Bank and Donald A.
      Pitcher dated December 31, 2008*#10.61
              Amendment
      to the Split Dollar Agreement between Temecula Valley Bank and Jim Andrews
      dated December 31, 2008*#10.62
              Amended
      and Restated Declaration of Trust among Temecula Valley Bancorp,
      Wilmington Trust Company and the Administrative Trustees dated September
      27, 2006 (included in Temecula Valley Bancorp’s Form 8-K, filed October 3,
      2006 andincorporated herein by reference)23.1
              Consent
      of Independent Registered Public Accountants *31.1
              Rule
      13a-14(a) Certification of Chief Executive Officer *31.2
              Rule
      13a-14(a) Certification of Chief Financial Officer *32.1
              Section
      1350 Certifications of Chief Executive Officer and Chief Financial Officer
      *_____*Filed
      herewith#
      Management
      contract or compensatory plan or
      arrangement


83