**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, 2006





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
      “Global Select Market”





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 [ ]





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, 2006 was approximately $183,729,176 (based on the
      June
      30, 2006 closing price of common stock of $20.10 per share).





Number
      of Registrant’s shares of common stock outstanding at March 8, 2007 was
      10,613,659.





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







**TABLE
      OF CONTENTS**


**PART
                I**ITEM
                1:
              
              BUSINESS
              4ITEM
                1A:
              
              RISK
                FACTORS
              27ITEM
                1B:
              
              UNRESOLVED
                STAFF COMMENTS
              33ITEM
                2:
              
              PROPERTIES
              33ITEM
                3:
              
              LEGAL
                PROCEEDINGS
              33ITEM
                4:
              
              SUBMISSION
                OF MATTERS TO A VOTE OF SECURITY HOLDER
              33**PART
                II**
              
              
              34ITEM
                  5:
              
              MARKET
                  FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND
                  ISSUER
                  PURCHASES OF EQUITY SECURITIES
              34ITEM
                6:
              
              SELECTED
                FINANCIAL DATA
              35ITEM
                7:
              
              MANAGEMENT
                DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
                OPERATIONS
              39ITEM
                7A:
              
              QUANTITATIVE
                AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
              54ITEM
                8:
              
              FINANCIAL
                STATEMENTS AND SUPPLEMETARY DATA
              55ITEM
                9:
              
              CHANGES
                IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
                DISCLOSURE
              55ITEM
                  9A:
              
              CONTROLS
                AND PROCEDURES
              55ITEM
                  9B:
              
              OTHER
                INFORMATION
              56**PART
                III**
              
              
              56ITEM
                10:
              
              DIRECTORS,
                EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
              56ITEM
                11:
              
              EXECUTIVE
                COMPENSATION
              56ITEM
                12:
              
              SECURITY
                OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
                STOCKHOLDER MATTERS
              56ITEM
                13:
              
              CERTAIN
                RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
                INDEPENDENCE
              56ITEM
                  14:
              
              PRINCIPAL
                ACCOUNTING FEES AND SERVICES
              56**PART
                IV**
              
              
              57ITEM
                15:
              
              EXHIBITS,
                FINANCIAL STATEMENT SCHEDULES
              57SIGNATURES
              58EXHIBIT
                LIST
              59REPORT
                OF INDEPENDENT REGISTERED
                PUBLIC ACCOUNTING FIRM
              60NOTES
                TO THE
                CONSOLIDATED FINANCIAL STATEMENTS
              66INDEX
                TO EXHIBITS
              85





2


**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
                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


·
            reduce
                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 shares of our bank, Temecula Valley Statutory Trust I, Temecula
      Valley Statutory Trust II, Temecula Valley Statutory Trust III, Temecula Valley
      Statutory Trust IV, and Temecula Valley Statutory Trust V. 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.





Since
      we
      opened our bank in 1996, we have experienced substantial annual growth. We
      continue to have strong growth in loans and deposits. We plan to continue to
      expand through new full-service and/or loan production office locations if
      they
      make good business sense and are located within our geographic service areas
      or
      contiguous markets.





**General
      Business**





Our
      bank currently has ten 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, 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, Colorado, Florida, Indiana, Nebraska, Nevada,
      Ohio,
      Oregon, Texas, and Washington.





Our
      bank
      offers a broad range of banking services, including personal and business
      checking accounts and various types of interest-bearing deposit accounts,
      including interest-bearing checking, money market, savings, IRA, SEP, and time
      certificates of deposits. In addition, our bank has developed a nationwide
      SBA
      lending program as a “preferred lender”. Through this program, we originate and
      fund both “7(a)” and “504” loans, primarily secured by commercial real estate
      property and guaranteed up to 85% by the Small Business Administration. Loan
      products include consumer installment (primarily automobile loans), home equity
      lines of credit, single-family residential construction loans, on both an
      owner-occupied and a non-owner basis, single family residential tract loans
      (over 4 units), commercial construction and permanent loans for office, retail
      and industrial buildings for owner-occupancy, investment and re-sale, commercial
      lines of credit, term loans and letters of credit for local businesses, and
      residential mortgage financing including conventional, VA, FHA, and Cal Vet
      loans.





We
      fund
      our lending activities primarily from our core deposit base and our Certificate
      of Deposit Money Desk. We obtain deposits from the local market with no material
      portion (in excess of 10% of total deposits) dependent upon any one person,
      entity or industry.





Our
      bank
      also offers safe deposit boxes, night depository facilities, merchant credit
      card services, notary services, travelers checks, note collection, wire transfer
      services, cashiers checks, drive up facilities at some locations, 24 hour ATM
      banking services, telephone banking, internet banking, direct deposit, and
      automatic transfers between accounts. Our bank is a member of the regional
      ATM
      network and offers nationwide ATM access.





4


Our
      holding company, as the parent of our bank, has no operations and conducts
      no
      business of its own other than owning our bank, Temecula Valley Statutory Trust
      I, Temecula Valley Statutory Trust II, Temecula Valley Statutory Trust III,
      Temecula Valley Statutory Trust IV, and Temecula Valley Statutory Trust V.
      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.





**Business
      Strategy**





Our
      goals
      are to build a leading Southern California regional community banking franchise
      and 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 producers. Our senior management team of 11 members averages more
      than 30 years of banking experience per individual and includes two former
      CEOs,
      five former CLOs/CCOs/SLOs and two former CFOs/COOs, several of whom have held
      senior management positions at other financial institutions with assets
      exceeding $1 billion. We believe that our customers significantly benefit from
      having access to experienced bankers. We believe that our management depth
      is
      far greater than typically seen at community banks of similar or greater
      size.





*Expanding
      our Community Banking Model* .
      Our
      goal is to deliver superior commercial loan and deposit products to expand
      our
      customer base in existing markets. For example, 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.
      In
      addition, we provide a one-on-one total banking relationship that may not be
      available at larger financial institutions. We will continue to cross-sell
      our
      business services and cash management products to enhance and maximize our
      banking relationships with our customers. A highly experienced and customer
      driven staff will differentiate us from our competition.





We
      opened
      two new branches in 2004, one new branch in 2005 and two branches in 2006.
      Ontario, California, our most recent expansion area, continues to be the
      business hub of the Inland Empire. This marketplace will provide a wide spectrum
      of business banking opportunities. We will continue to explore branch expansion
      opportunities as skilled bankers become available in or around our market
      areas.





Branch
      offices are staffed by proven managers with long-standing ties within the
      communities they serve. As a complement to our loan production offices, we
      use
      the relationships of our branch staff to provide lending products to customers
      in the Southern California markets we serve. In particular, we expect to see
      our
      commercial and industrial loan portfolio grow with the addition of the Ontario
      team serving the San Bernardino County market.





*Maintaining
      Strength in Construction Lending.* Our Real
      Estate Industries Group (REIG) specializes in residential, commercial and
      industrial construction loans to established, mid-sized builders in established
      markets. In Southern California, the predominate product of choice has been
      residential tracts located throughout the Inland Empire (Riverside and San
      Bernardino Counties). 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 have been customers of the loan officers for more than
      15
      years. 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. In December 2006, we began increasing the
      products available to our BDOs. We hope 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, among others.





5


In
      January 2007, we closed our regional SBA offices in the northeast and southeast
      areas of the country except that we retained one office in Florida. It is
      anticipated that this reorganization will result in cost savings greater than
      the income generated from the closed offices. As a result of these actions,
      we
      are placing greater emphasis and resources on generating SBA loans in the mid
      and western United States.





In
      addition to the origination of SBA loans through our current network of BDOs,
      we
      have initiated a program to purchase participations in the unguaranteed portions
      of SBA 7(a) loans from other lenders. The team we have in place to manage this
      program includes individuals who have successfully managed similar portfolios
      at
      other financial institutions.





*Overview
      of Performance.* Our profitability goals have been realized
      historically by increases in net interest income as well as expense controls
      during several consecutive years of significant internal expansion. This
      produced record earnings for 2006 of $16.9 million, compared to $14.0 million
      in
      2005, and $10.6 million in 2004. Return on average equity was 23.89% for 2006,
      compared to 27.71% for 2005, and 28.94% in 2004. Return on average total assets
      was 1.64% for 2006, compared to 1.91% for 2005, and 2.00% for 2004. Our
      management expects that during 2007, net income will increase over the results
      in 2006 by at least 10% but cannot guarantee these results.





Net
      interest income before provision for loan losses has increased to $59.8 million
      for 2006, compared to $43.5 million for 2005, and $27.2 million in 2004 due
      to
      increases in rates and volume of interest-earning assets. Total assets increased
      42.49% to $1.24 billion as of December 31, 2006, compared to $869.0 million
      as
      of December 31, 2005, and $606.8 million as of December 31, 2004. Average
      interest-earning assets increased 46.26% to $939.2 million for 2006, compared
      to
      $642.2 million for 2005, and $454.8 million in 2004. The net interest margin
      has
      decreased to 6.37% in 2006 from 6.78% in 2005, and up from 5.98% in
      2004.





Non-interest
      income was $19.4 million as of December 31, 2006, compared to $23.8 million
      for
      2005, and $28.7 million for 2004. This source of income is principally derived
      from SBA loan sales. The decrease in non-interest income in 2006 is primarily
      due to the decrease in servicing income as a result of unusually high
      prepayments. We currently anticipate that for 2007, non-interest income will
      increase due to decreased amortization of the SBA servicing assets as a result
      of lower prepayments and the reduction of serviced SBA 7(a) loans that have
      higher retained servicing.





We
      measure operating expenses as a percentage of average assets. As a percentage
      of
      average assets, operating expenses decreased to 4.56% for 2006, compared to
      5.57% for 2005, and 6.43% for 2004. Average assets increased from $528.2 million
      as of December 31, 2004, to $730.0 million as of December 31, 2005, and $1.03
      billion as of December 31, 2006. The 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.





**Lending**





***Loan
      Portfolio Composition***





Total
      loans, including loans held-for-sale, excluding deferred loan fees, and
      allowance for loan loss, were $1.15 billion at December 31, 2006, compared
      to
      $758.1 million at December 31, 2005, and $533.9 million at December 31, 2004.
      Contributing to the increase was the outstanding balance of the purchase of
      the
      unguaranteed portion of 7(a) loans in the amount of $120.3 million. Without
      the
      purchase of these loans, the increase in total loans, excluding loans
      held-for-sale, would have been $267.8 million or 35.32%. Loan growth is expected
      to remain strong in 2007 due to the expansion of our branches, growth of the
      SBA
      unguaranteed purchase program, 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 19% of net loans outstanding as of December 31, 2006
      and
      13% of net loans outstanding as of December 31, 2005. Typical of community
      bank
      loan markets, a significant portion of our portfolio is real estate secured.
      Approximately 94% of our loan portfolio at December 31, 2006 was real estate
      secured, compared to 95% at December 31, 2005 and 94% at December 31, 2004.
      Approximately 50%, 51%, and 38% of our lending portfolio was classified as
      real
      estate construction loans as of December 31, 2006, 2005, and 2004,
      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, 2006 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, 2006, is
      approximately 401%. 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.





6


The
      weighted-average loan-to-value for our real estate loan portfolio, excluding
      owner occupied properties, is approximately 60% at December 31, 2006. 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
                31,2006
            
            2005
            
            2004
            
            2003
            
            2002Amount
            Percent
            
            Amount
            Percent
            
            Amount
            Percent
            
            Amount
            Percent
            
            Amount
            Percent(dollars
                in thousands)Commercial
            $
            59,663
            5
            %
            
            $
            25,457
            3
            %
            
            $
            16,322
            3
            %
            
            $
            23,630
            7
            %
            
            $
            24,578
            9
            %Real
                estate - Construction
            
            570,204
            50
            %
            
            
            385,378
            51
            %
            
            
            203,885
            38
            %
            
            
            113,847
            31
            %
            
            
            61,568
            23
            %Real
                estate - Other
            
            294,220
            25
            %
            
            
            248,039
            32
            %
            
            
            196,098
            36
            %
            
            
            123,948
            34
            %
            
            
            105,731
            39
            %SBA
            
            218,457
            19
            %
            
            
            94,914
            13
            %
            
            
            114,799
            22
            %
            
            
            98,428
            27
            %
            
            
            76,433
            28
            %Consumer
            
            3,685
            1
            %
            
            
            4,306
            1
            %
            
            
            2,796
            1
            %
            
            
            3,193
            1
            %
            
            
            4,456
            1
            %Total
                Loans
            $
            1,146,229
            100
            %
            
            $
            758,094
            100
            %
            
            $
            533,900
            100
            %
            
            $
            363,046
            100
            %
            
            $
            272,766
            100
            %




***Loan
      Maturity***





The
      following table sets forth the contractual maturities of gross loans at
      December 31, 2006.





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
            $
            43,957
            
            $
            7,868
            
            $
            4,564
            
            $
            3,274
            
            $
            59,663Real
                estate - Construction
            
            438,213
            
            
            42,725
            
            
            -
            
            
            89,266
            
            
            570,204Real
                estate - Other
            
            89,717
            
            
            24,888
            
            
            15,953
            
            
            163,662
            
            
            294,220SBA
            
            8,465
            
            
            147
            
            
            1,523
            
            
            208,322
            
            
            218,457Consumer
            
            808
            
            
            402
            
            
            -
            
            
            2,475
            
            
            3,685Total
                Gross Loans Outstanding
            $
            581,160
            
            $
            76,030
            
            $
            22,040
            
            $
            466,999
            
            $
            1,146,229





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,
      2006, 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
            $
            5,384
            
            $
            10,322
            
            $
            15,706Real
                estate - Construction
            
            4,370
            
            
            127,621
            
            
            131,991Real
                estate - Other
            
            19,281
            
            
            185,222
            
            
            204,503SBA
            
            4,033
            
            
            205,959
            
            
            209,992Consumer
            
            1,451
            
            
            1,426
            
            
            2,877Total
                Gross Loans Outstanding
            $
            34,519
            
            $
            530,550
            
            $
            565,069





7


***Loan
      Origination and Sale***





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





At
                December 31,2006
            
            2005
            
            2004
            
            2003
            
            2002(dollars
                in thousands)Beginning
                balance
            $
            758,094
            
            $
            533,900
            
            $
            363,046
            
            $
            272,766
            
            $
            150,964Loans
                originated:Commercial
            
            437,323
            
            
            323,219
            
            
            237,064
            
            
            161,376
            
            
            144,399Real
                estate:SBA
                & Equity
            
            177,379
            
            
            167,402
            
            
            225,373
            
            
            192,549
            
            
            166,563Construction
            
            1,239,794
            
            
            897,862
            
            
            574,150
            
            
            367,464
            
            
            186,741Other
            
            -
            
            
            11,281
            
            
            44,942
            
            
            96,051
            
            
            85,281Consumer
            
            5,382
            
            
            5,200
            
            
            1,869
            
            
            2,422
            
            
            4,298Total
                loans originated
            
            1,859,878
            
            
            1,404,964
            
            
            1,083,398
            
            
            819,862
            
            
            587,282Loans
                purchased:SBA
            
            133,336
            
            
            -
            
            
            -
            
            
            -
            
            
            -Total
                loans originated and purchased
            
            1,993,214
            
            
            1,404,964
            
            
            1,083,398
            
            
            819,862
            
            
            587,282Loans
                soldCommercialReal
                estate:SBA
            
            160,478
            
            
            151,191
            
            
            199,236
            
            
            129,813
            
            
            108,213Construction
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Other
                - Mortgage
            
            -
            
            
            13,707
            
            
            45,243
            
            
            100,800
            
            
            83,014Total
                loans sold
            
            160,478
            
            
            164,898
            
            
            244,479
            
            
            230,613
            
            
            191,227Less:Principal
                repayments
            
            1,444,601
            
            
            1,015,872
            
            
            668,065
            
            
            498,969
            
            
            274,253Total
                loans
            $
            1,146,229
            
            $
            758,094
            
            $
            533,900
            
            $
            363,046
            
            $
            272,766Brokered
                Loans Originated (1)Mortgage
            $
            96,733
            
            $
            63,735
            
            $
            60,604
            
            $
            65,358
            
            $
            72,743SBA
            $
            65,609
            
            $
            52,470
            
            $
            154,515
            
            $
            65,456
            
            $
            29,612




***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.





8


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 2006, 7(a) loans have represented approximately 66% 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 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 6% and 10% 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. We have repurchased 35 loans, however only 1 of these repurchased
      loans required a refund of the premium. No refunds were owed on the other
      34 **** loans
      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 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 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. The
      first trust deed loans may be pre-sold with no recourse, before releasing the
      funds to the purchaser. We retain no servicing on 504 Loans after they are
      sold.





9


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, 2006 was $22.0 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 5 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 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 two types of residential
      construction loans, owner-occupied and speculative. We also originate
      owner-occupied construction loans to build single family residences. We will
      originate speculative 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 speculative 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 "spec" single family residences and commercial properties and
      up to
      80% 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, 2006, construction loans, including land acquisition and development loans
      totaled $570.2 million or approximately 50% 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.


10


***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, 2006,
      consumer loans totaled $3.7 million.





As
      of
      December 31, 2006, home equity loans totaled $3.1 million, or 3% our gross
      loan
      portfolio. Our home equity loans 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***





Sold
      loans 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. The loan servicing
      is
      centralized at our corporate headquarters. As of December 31, 2006, we were
      servicing $480.1 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 and
      senior liens. When payments are not received by their contractual due date,
      collection efforts begin on the 11 th 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. In 2006 our bank hired an Internal Loan Review Officer
      who reviews each profit center’s loan operations on an annual basis and each
      loan over $5.0 million. Loan officers are responsible for continually grading
      their loans so that individual credits properly reflect the risk inherent
      therein. On an 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, 94% **** of
      which
      are secured by real estate. 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
      concentration of 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, 2006,
      this
      amount was $22.0 million).




11


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. Our company's policies provide that all investment
      purchases, that are outside our policy guidelines, 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, our Chief Financial Officer or our Chief Operating Officer. At
      December 31, 2006, we held $1.0 million in FNMA Mortgage-backed securities,
      $2.0 million in Federal Home Loan Bank (“FHLB”) stock, and $18.2 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 $19.3 million of nonperforming loans as of December 31 2006, of which $10.3
      million was guaranteed by the SBA, compared to $8.0 million of nonperforming
      loans as of December 31, 2005, of which $6.5 million was government guaranteed
      and $11.8 million of nonperforming loans as of December 31, 2004, of which
      $8.1
      million was government guaranteed. There was $1.3 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.





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 loans to total loans (after reducing for SBA guarantees) was
      0.77%, 0.19%, and 0.69% for the years ended 2006, 2005, and 2004, 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, however, 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. We had no restructured loans as of
      December 31, 2006 or 2005. Restructured loans totaled $154 thousand at
      December 31, 2004. 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.




12


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:




December
                31, 2006
            
            December
                31, 2005Gross
            
            Government
            
            Net
            
            Gross
            
            Government
            
            NetBalance
            
            Guaranteed
            
            Balance
            
            Balance
            
            Guaranteed
            
            BalanceNonaccrual
                loans (Gross):
            (dollars
                in thousands)Commercial
            $
            89
            
            
            $
            (44
            )
            
            $
            45
            
            
            $
            2,259
            
            
            $
            (2,178
            )
            
            $
            81Real
                Estate - Construction
            
            5,942
            
            
            
            -
            
            
            
            5,942
            
            
            
            -
            
            
            
            -
            
            
            
            -Real
                Estate - Other
            
            13,093
            
            
            
            (10,290
            )
            
            
            2,803
            
            
            
            5,692
            
            
            
            (4,336
            )
            
            
            1,356Installment
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Total
            
            19,124
            
            
            
            (10,334
            )
            
            
            8,790
            
            
            
            7,951
            
            
            
            (6,514
            )
            
            
            1,437OREO
            
            1,255
            
            
            
            (638
            )
            
            
            617
            
            
            
            2,111
            
            
            
            (604
            )
            
            
            1,507Total
                nonaccrual loans and OREO
            $
            20,379
            
            
            $
            (10,972
            )
            
            $
            9,407
            
            
            $
            10,062
            
            
            $
            (7,118
            )
            
            $
            2,944Gross
                nonaccrual loans as a percentage of total loans
            
            
            
            
            1.67
            %
            
            
            
            
            
            
            
            
            
            
            1.06
            %Gross
                nonaccrual loans and OREO as a percentage of total loans and
                OREO
            
            
            
            1.78
            %
            
            
            
            
            
            
            
            
            
            
            1.34
            %Allowance
                for loan losses to total net loans (including
                held-for-sale)
            
            
            
            1.10
            %
            
            
            
            
            
            
            
            
            
            
            1.20
            %Allowance
                for loan losses to total net loans (excluding
                held-for-sale)
            
            
            
            1.29
            %
            
            
            
            
            
            
            
            
            
            
            1.35
            %Allowance
                for loan losses to gross nonaccrual loans
            
            
            
            
            
            
            
            65.48
            %
            
            
            
            
            
            
            
            
            
            
            113.69
            %Loans
                past due 90 days or more on accrual status:Commercial
            
            
            
            
            
            
            
            
            $
            26
            
            
            
            
            
            
            
            
            
            
            $
            -Real
                Estate
            
            
            
            
            
            
            
            
            
            114
            
            
            
            
            
            
            
            
            
            
            
            -Installment
            
            
            
            
            
            
            
            
            
            -
            
            
            
            
            
            
            
            
            
            
            
            -Total
            
            
            
            
            
            
            
            
            $
            140
            
            
            
            
            
            
            
            
            
            
            $
            -





The
      table
      below summarizes the approximate changes in gross nonaccrual loans for the
      years
      ended December 31, 2006, 2005, and 2004.




2006
            
            
            2005
            
            
            2004(dollars
                in thousands)Balance,
                beginning of the year
            $
            7,951
            
            
            $
            11,799
            
            
            $
            6,675Loans
                placed on nonaccrual
            
            15,265
            
            
            
            3,840
            
            
            
            5,293Charge-offs
            
            (381
            )
            
            
            (540
            )
            
            
            (1,097
            )Loans
                returned to accrual status
            
            (3,936
            )
            
            
            (6,586
            )
            
            
            -Repayments
                (including interest applied to principal)
            
            2,356
            
            
            
            1,920
            
            
            
            2,338Transfers
                to OREO
            
            (2,131
            )
            
            
            (2,482
            )
            
            
            (1,410
            )Balance,
                end of year
            $
            19,124
            
            
            $
            7,951
            
            
            $
            11,799





The
      additional interest income that would have been recorded from nonaccrual loans
      if the loans had not been on nonaccrual status, was $2.0 million, $898 thousand,
      and $549 thousand for the years ended December 31, 2006, 2005, and 2004,
      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 22 basis points, 14 basis
      points, and 12 basis points for the years ended December 31, 2006, 2005,
      and 2004, respectively.





**Other
      Real Estate Owned**





Other
      Real Estate Owned (“OREO”) was $1.3 million at December 31, 2006, of which $638
      thousand was guaranteed by the SBA, compared $2.1 million at December 31, 2005,
      of which $604 thousand was guaranteed by the SBA, and $303 thousand at
      December 31, 2004, of which $227 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**





At
      December 31, 2006, in addition to loans disclosed above as past due,
      nonaccrual or restructured, management also identified $9.3 million of
      additional classified loans, net of SBA guaranteed loans, where the ability
      to
      comply with the present loan payment terms in the future is questionable.
      However, the inability of the borrowers to comply with repayment terms was
      not
      sufficiently probable to place these loans on nonaccrual status at December 31,
      2006. This amount was determined based on analysis
      of information known to management about the borrowers'
      financial condition and current economic conditions. Estimated potential losses
      from these potential problem loans have been provided for in determining the
      allowance for loan losses at December 31, 2006.





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





13


**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-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 somewhat dependent on real estate and
      related industries (i.e. construction, housing). While we maintain a reasonably
      diverse commercial and consumer loan portfolio, any major downturn in real
      estate or construction could have an adverse effect on borrowers' ability to
      repay loans and, therefore, could potentially affect our results of operations
      and financial condition.


Consequently,
      in evaluating our allowance for loan losses, management incorporates, among
      many
      other factors, the effect on borrowers of an economic downturn in the real
      estate related industries, the diversification of the loan portfolio, and
      economic indicators and conditions. 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.





14


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. Examples of inherent risks in the loan portfolio
      include the quality of the loans, the concentrations of credit by collateral
      and
      industries, our bank's lending staff and policies, and external factors such
      as
      economic conditions. The following table summarizes the activity in the
      allowance for loan losses for the five years ended December 31,
      2006:


Allowance
                for Loan LossesYear
                ended December 31,2006
            
            
            2005
            
            
            2004
            
            
            2003
            
            
            2002(dollars
                in thousands)Loans
                outstanding and loans held-for-sale
            $
            1,142,693
            
            
            $
            753,246
            
            
            $
            530,196
            
            
            $
            360,749
            
            
            $
            268,409Average
                amount of loans outstanding
            
            922,264
            
            
            
            634,731
            
            
            
            446,493
            
            
            
            318,600
            
            
            
            284,849Balance
                of allowance for loan losses,
              beginning
                of years
            
            9,039
            
            
            
            6,362
            
            
            
            3,608
            
            
            
            3,017
            
            
            
            1,239Loans
                charged off:Commercial
            
            (208
            )
            
            
            (250
            )
            
            
            (986
            )
            
            
            (464
            )
            
            
            (338
            )Real
                Estate - Construction
            
            (10
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Real
                Estate - Other
            
            (159
            )
            
            
            (286
            )
            
            
            (105
            )
            
            
            (37
            )
            
            
            (354
            )Consumer
            
            (4
            )
            
            
            (4
            )
            
            
            (6
            )
            
            
            (4
            )
            
            
            (15
            )Total
                loans charged off
            $
            (381
            )
            
            $
            (540
            )
            
            $
            (1,097
            )
            
            $
            (505
            )
            
            $
            (707
            )Recoveries
                of loans previously charged off:Commercial
            
            202
            
            
            
            281
            
            
            
            23
            
            
            
            19
            
            
            
            11Real
                Estate - Construction
            
            10
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Real
                Estate - Other
            
            1
            
            
            
            39
            
            
            
            3
            
            
            
            33
            
            
            
            3Consumer
            
            1
            
            
            
            -
            
            
            
            4
            
            
            
            22
            
            
            
            11Total
                recoveries
            $
            214
            
            
            $
            320
            
            
            $
            30
            
            
            $
            74
            
            
            $
            25Net
                loans charged off
            
            (167
            )
            
            
            (220
            )
            
            
            (1,067
            )
            
            
            (431
            )
            
            
            (682
            )Provision
                for Loan loss expense
            
            3,650
            
            
            
            2,897
            
            
            
            3,821
            
            
            
            1,022
            
            
            
            2,460Balance,
                end of year
            $
            12,522
            
            
            $
            9,039
            
            
            $
            6,362
            
            
            $
            3,608
            
            
            $
            3,017




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.


15





**At
                the Years Ended December 31,**2006
            
            2005Allowance
                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
            $
            658
            
            
            5.3
            %
            
            5.2
            %
            
            $
            254
            
            
            2.8
            %
            
            3.4
            %Real
                Estate
            
            2,159
            
            
            17.2
            %
            
            25.7
            %
            
            
            2,027
            
            
            22.4
            %
            
            32.7
            %Construction/Land
                Development
            
            5,658
            
            
            45.2
            %
            
            49.8
            %
            
            
            4,253
            
            
            47.1
            %
            
            50.7
            %Mortgage
            
            -
            
            
            0.0
            %
            
            0.0
            %
            
            
            -
            
            
            0.0
            %
            
            0.0
            %SBA
            
            4,008
            
            
            32.0
            %
            
            19.1
            %
            
            
            2,462
            
            
            27.2
            %
            
            12.6
            %Consumer
                & Other
            
            39
            
            
            0.3
            %
            
            0.2
            %
            
            
            43
            
            
            0.5
            %
            
            0.6
            %Total
            $
            12,522
            
            
            100.0
            %
            
            100.0
            %
            
            $
            9,039
            
            
            100.0
            %
            
            100.0
            %**At
                the Years Ended December 31,**2004
            
            2003Allowance
                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
            $
            178
            
            
            2.8
            %
            
            3.1
            %
            
            $
            154
            
            
            4.3
            %
            
            6.5
            %Real
                Estate
            
            1,590
            
            
            25.0
            %
            
            36.4
            %
            
            
            655
            
            
            18.2
            %
            
            33.4
            %Construction/Land
                Development
            
            1,958
            
            
            30.7
            %
            
            38.0
            %
            
            
            589
            
            
            16.3
            %
            
            31.2
            %Mortgage
            
            -
            
            
            0.0
            %
            
            0.4
            %
            
            
            -
            
            
            0.0
            %
            
            0.7
            %SBA
            
            2,612
            
            
            41.1
            %
            
            21.6
            %
            
            
            2,184
            
            
            60.5
            %
            
            27.3
            %Consumer
                & Other
            
            24
            
            
            0.4
            %
            
            0.5
            %
            
            
            26
            
            
            0.7
            %
            
            0.9
            %Total
            $
            6,362
            
            
            100.0
            %
            
            100.0
            %
            
            $
            3,608
            
            
            100.0
            %
            
            100.0
            %**At
                the Year Ended December 31,**2002Allowance
                Amount
            
            %
                of Allowance to Total Amount
            
            %
                in Loans in Each Category to Total Loans(dollars
                in thousands)Commercial
            $
            172
            
            
            5.7
            %
            
            9.1
            %Real
                Estate
            
            667
            
            
            22.1
            %
            
            35.9
            %Construction/Land
                Development
            
            391
            
            
            13.0
            %
            
            22.4
            %Mortgage
            
            -
            
            
            0.0
            %
            
            2.8
            %SBA
            
            1,741
            
            
            57.7
            %
            
            28.2
            %Consumer
                & Other
            
            46
            
            
            1.5
            %
            
            1.6
            %Total
            $
            3,017
            
            
            100.0
            %
            
            100.0
            %





The
      allowance for loan losses as a percentage of net loans outstanding and loans
      held-for-sale was 1.10% as of December 31, 2006, and 1.20% as of December 31,
      2005 and 2004. The allowance for loan losses as a percentage of net loans
      outstanding, excluding loans held-for-sale, was 1.29% as of December 31, 2006,
      1.35% as of December 31 2005, and 1.29% as of December 31, 2004.





As
      a
      result of past decreases in local and regional real estate values and the
      significant losses experienced by many financial institutions, there has been
      a
      greater level of scrutiny by regulatory authorities of the loan portfolios
      of
      financial institutions undertaken as a part of the examinations of such
      institutions by banking regulators. 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.


16


**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, 2006, 2005, and 2004 are represented below.





**Years
                Ended December 31,**2006
            
            
            
            
            
            
            2005Average
                Balance
            
            %
                of total Average Deposits / Borrowings
            
            Average
                Rate %
            
            Average
                Balance
            
            %
                of total Average Deposits / Borrowings
            
            Average
                Rate %(dollars
                in thousands)NOW
            $
            31,161
            
            3.3%
            
            0.15%
            
            $
            32,791
            
            4.9%
            
            0.15%Money
                Market
            
            83,672
            
            8.8%
            
            3.26%
            
            
            50,239
            
            7.5%
            
            1.81%Savings
            
            31,685
            
            3.3%
            
            0.39%
            
            
            38,010
            
            5.7%
            
            0.37%Time
                deposits less than $100,000
            
            293,909
            
            31.0%
            
            4.72%
            
            
            175,124
            
            26.1%
            
            3.17%Time
                deposits $100,000 and over
            
            315,346
            
            33.3%
            
            4.74%
            
            
            194,496
            
            29.0%
            
            3.24%Other
                Borrowings
            
            36,906
            
            3.9%
            
            7.41%
            
            
            28,993
            
            4.3%
            
            5.64%Total
                interest-bearing liabilities
            
            792,679
            
            83.6%
            
            4.35%
            
            
            519,653
            
            77.5%
            
            2.81%Non
                interest-bearing deposits
            
            154,473
            
            16.4%
            
            0.00%
            
            
            151,447
            
            22.5%
            
            0.00%Total
                Deposits & Other Borrowings
            $
            947,152
            
            100.0%
            
            3.64%
            
            $
            671,100
            
            100.0%
            
            2.17%**Year
                Ended December 31,**2004Average
                Balance
            
            %
                of total Average Deposits / Borrowings
            
            Average
                Rate %(dollars
                in thousands)NOW
            $
            31,588
            
            6.5%
            
            0.14%Money
                Market
            
            37,770
            
            7.8%
            
            1.21%Savings
            
            40,699
            
            8.4%
            
            0.46%Time
                deposits less than $100,000
            
            113,802
            
            23.4%
            
            2.13%Time
                deposits $100,000 and over
            
            112,964
            
            23.3%
            
            2.20%Other
                Borrowings
            
            20,195
            
            4.2%
            
            4.06%Total
                interest-bearing liabilities
            
            357,018
            
            73.6%
            
            1.80%Non
                interest-bearing deposits
            
            128,670
            
            26.4%
            
            0.00%Total
                Deposits & Other Borrowings
            $
            485,688
            
            100.0%
            
            1.32%




At
      December 31, 2006, we had $409.8 million in time deposits in the amounts of
      $100,000 or more, consisting of 2,319 accounts, maturing as
      follows:





Maturity
                Period
            
            Amount
            Weighted
                Average Rate(dollars
                in thousands)Three
                months or less
            $
            157,819
            5.10%Greater
                than Three Months to Six Months
            
            133,894
            5.19%Greater
                than Six Months to Twelve Months
            
            117,448
            5.28%Greater
                than Twelve Months
            
            648
            4.40%Total
            $
            409,809
            5.19%


17


**Short-term
      Borrowings**




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




Year
                Ended December 31,2006
            
            
            2005
            
            
            2004(dollars
                in thousands)FHLB
                advances
            $
            -
            
            $
            30,000
            
            $
            -Total
                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.





**Supervision
      and Regulation**





Bank
      holding companies and banks are extensively regulated under state and federal
      law. 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.





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.





In
      addition, insured depository institutions under common control are required
      to
      reimburse the FDIC for any loss suffered by its deposit insurance funds as
      a
      result of the default of a commonly controlled depository institution or for
      any
      assistance provided by the FDIC to a commonly controlled insured depository
      institution in danger of default. The FDIC may decline to enforce the
      cross-guarantee provisions if it determines that a waiver is in the best
      interest of the deposit insurance funds. The FDIC's claim for damages is
      superior to claims of stockholders of the insured depository institution or
      its
      holding company but is subordinate to claims of depositors, secured creditors
      and holders of subordinated debt (other than affiliates) of the commonly
      controlled insured depository institutions.





As
      a
      California state-chartered bank, we are subject to supervision, periodic
      examination and regulation by the California Department of Financial
      Institutions (“DFI”) and the Federal Reserve Bank. Our bank's deposits are
      insured (presently $100,000 per account; $250,000 in the case of
      certain retirement accounts) by the Deposit Insurance Fund ("DIF") which is
      operated by the FDIC. As a result of this deposit insurance function, the FDIC
      also has certain supervisory authority and powers over our bank as well as
      all
      other FDIC insured institutions. If, as a result of an examination of our bank,
      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 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. Our bank is also subject
      to
      certain provisions of California law.





18


Because
      California **** permits
      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.





Various
      requirements and restrictions under the laws of the United States affect the
      operations of our bank. Statutes and regulations relate to many aspects 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.





**Recent
      and Proposed Legislation**





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.




***Sarbanes-Oxley
      Act*** ***of 2002***





The
      Sarbanes-Oxley Act of 2002 (“SOX”), was signed into law to address corporate
      governance and accounting oversight matters of companies whose securities are
      registered under the Securities Exchange Act. SOX established the Public Company
      Accounting Oversight Board (“PCAOB”), a new 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.





As
      with
      most other companies that are required to comply with SOX, we have incurred,
      and
      will in the future incur, significant costs as a result of its compliance
      efforts. Such costs and efforts, however, are not expected to have a material
      adverse effect upon our financial results.





***USA
      PATRIOT Act***





The
      Uniting and Strengthening America by Providing Appropriate Tools Required to
      Intercept and Obstruct Terrorism Act of 2001 (“USA PATRIOT Act”) and its
      implementing regulations significantly expanded the anti-money laundering and
      financial transparency laws. 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. For example, the enhanced due
      diligence policies, procedures and controls generally require financial
      institutions to take reasonable steps





·
            to
                conduct enhanced scrutiny of account relationships to guard against
                money
                laundering and report any suspicious
                transaction


·
            to
                determine the identity of the nominal and beneficial owners of, and
                the
                source of funds deposited into, each account as needed to guard against
                money laundering and report any suspicious
                transactions


·
            to
                determine for any foreign bank, the shares of which are not publicly
                traded, the identity of the owners of the foreign bank and the nature
                and
                extent of the ownership interest of each such
                owner


·
            to
                determine whether any foreign bank provides correspondent accounts
                to
                other foreign banks and, if so, the identity of those foreign banks
                and
                related due diligence information





Under
      the
      USA PATRIOT Act, financial institutions are required to establish and maintain
      anti-money laundering programs which include:




·
            the
                establishment of a customer identification
                program


·
            the
                development of internal policies, procedures, and
                controls


·
            the
                designation of a compliance officer


·
            an
                ongoing employee training program


·
            an
                independent audit function to test the
                programs





19


Our
      Board
      of Directors of our Bank has adopted comprehensive policies and procedures
      to
      address the requirements of the USA PATRIOT Act. Compliance has not had a
      material adverse effect upon us and it is not expected that future compliance
      will cause this to change. 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.





***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 has in the recent past
      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, describing the
                conditions under which they may disclose nonpublic personal information
                to
                nonaffiliated third parties and
                affiliates;


·
            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 must
      “opt in” before information may be disclosed to certain nonaffiliated 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.
      In
      connection with the FACT Act, financial institution regulatory agencies proposed
      rules that would prohibit an institution from using certain information about
      a
      consumer it received from an affiliate to make a solicitation to the consumer,
      unless the consumer has been notified and given a chance to opt out of such
      solicitations. A consumer’s election to opt out would be applicable for at least
      five years.





The
      Check
      Clearing for the 21st Century Act, or “Check 21”, facilitates check truncation
      and electronic check exchange by authorizing a new negotiable instrument called
      a “substitute check,” which is the legal equivalent of an original check. Check
      21 does not require banks to create substitute checks or accept checks
      electronically; however, it does require banks to accept a legally equivalent
      substitute check in place of an original. In addition to its issuance of
      regulations governing substitute checks, the Federal Reserve has issued final
      rules governing the treatment of remotely created checks (sometimes referred
      to
      as “demand drafts”) and electronic check conversion transactions (involving
      checks that are converted to electronic transactions by merchants and other
      payees).





20


The
      Equal
      Credit Opportunity Act, or “ECOA”, generally prohibits discrimination in any
      credit transaction, whether for consumer or business purposes, on the basis
      of
      race, color, religion, national origin, sex, marital status, age (except in
      limited circumstances), receipt of income from public assistance programs,
      or
      good faith exercise of any rights under the Consumer Credit Protection
      Act.




The
      Truth
      in Lending Act, or “TILA”, is designed to ensure that credit terms are disclosed
      in a meaningful way so that consumers may compare credit terms more readily
      and
      knowledgeably. As a result of the TILA, all creditors must use the same credit
      terminology to express rates and payments, including the annual percentage
      rate,
      the finance charge, the amount financed, the total of payments and the payment
      schedule, among other things.





The
      Fair
      Housing Act, or “FH Act”, regulates many practices, including making it unlawful
      for any lender to discriminate in its housing-related lending activities against
      any person because of race, color, religion, national origin, sex, handicap
      or
      familial status. A number of lending practices have been found by the courts
      to
      be, or may be considered, illegal under the FH Act, including some that are
      not
      specifically mentioned in the FH Act itself.





The
      Community Reinvestment Act, or “CRA”, is intended to encourage insured
      depository institutions, while operating safely and soundly, to help meet the
      credit needs of their communities. The CRA specifically directs the federal
      regulatory agencies, in examining insured depository institutions, to assess
      a
      bank’s record of helping meet the credit needs of its entire community,
      including low- and moderate-income neighborhoods, consistent with safe and
      sound
      banking practices. The CRA further requires the agencies to take a financial
      institution’s record of meeting its community credit needs into account when
      evaluating applications for, among other things, domestic branches, mergers
      or
      acquisitions, or holding company formations. The agencies use the CRA assessment
      factors to provide a rating to the financial institution. The ratings range
      from
      a high of “outstanding” to a low of “substantial noncompliance.” In our last
      examination for CRA compliance as of May 2004, our bank was rated
“satisfactory.”





The
      Home
      Mortgage Disclosure Act, or “HMDA”, grew out of public concern over credit
      shortages in certain urban neighborhoods and provides public information that
      will help show whether financial institutions are serving the housing credit
      needs of the neighborhoods and communities in which they are located. The HMDA
      also includes a “fair lending” aspect that requires the collection and
      disclosure of data about applicant and borrower characteristics as a way of
      identifying possible discriminatory lending patterns and enforcing
      anti-discrimination statutes. The Federal Reserve Board amended regulations
      issued under HMDA to require the reporting of certain pricing data with respect
      to higher priced mortgage loans for review by federal banking agencies from
      a
      fair lending perspective. We do not expect that the HMDA data report will raise
      material issues regarding our compliance with the fair lending
      laws.





The
      term
“predatory lending,” covers a potentially broad range of behavior. Typically,
      predatory lending involves at least one, and perhaps all three, of the following
      elements:





·
            making
                unaffordable loans based on the assets of the borrower rather than
                on the
                borrower’s ability to repay an obligation (“asset-based
                lending”)


·
            inducing
                a borrower to refinance a loan repeatedly in order to charge high
                points
                and fees each time the loan is refinanced (“loan
                flipping”)


·
            engaging
                in fraud or deception to conceal the true nature of the loan obligation
                from an unsuspecting or unsophisticated
                borrower.





FRB
      regulations aimed at curbing such lending significantly widen the pool of
      high-cost home-secured loans covered by the Home Ownership and Equity Protection
      Act of 1994, or “HOEPA”, a federal law that requires extra disclosures and
      consumer protections to borrowers. Lenders that violate the rules face
      cancellation of loans and penalties equal to the finance charges
      paid.





The
      Real Estate Settlement Procedures Act, or “RESPA”, requires lenders to provide
      borrowers with disclosures regarding the nature and cost of real estate
      settlements. Also, RESPA prohibits certain abusive practices, such as kickbacks,
      and places limitations on the amount of escrow accounts. Penalties under the
      above laws may include fines, reimbursements and other penalties.





Due
      to
      heightened regulatory concern related to compliance with the FACT Act, ECOA,
      TILA, FH Act, CRA, HMDA, HOEPA, and RESPA generally, we may incur additional
      compliance costs or be required to expend additional funds for investments
      in
      its local community.




21


***Guidance
      on Nontraditional Mortgage Products***





In
      September 2006, the federal banking agencies issued final guidance on
      residential mortgage products that allow borrowers to defer repayment of
      principal and sometimes interest, including “interest only” mortgage loans, and
“payment option” adjustable rate mortgages where a borrower has flexible payment
      options, including payments that have the potential for
      negative amortization. While acknowledging that innovations in mortgage lending
      can benefit some consumers, the final guidance states that management
      should:





·
            assess
                a borrower’s ability to repay the loan, including any balances added
                through negative amortization, at the fully indexed rate that would
                apply
                after the introductory period


·
            recognize
                that certain nontraditional mortgages are untested in a stressed
                environment and warrant strong risk management standards as well
                as
                appropriate capital and loan loss
                reserves


·
            ensure
                that borrowers have sufficient information to clearly understand
                loan
                terms and associated risks before making a product or payment
                choice.





We
      believe our products and disclosures are in conformance with the requirements
      of
      the guidance.





***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. Finally, pursuant to an interagency agreement, the FDIC can examine
      any
      institution that has a substandard regulatory examination score or is considered
      undercapitalized without the express permission of the institution’s primary
      regulator.





The
      federal banking agencies have adopted guidelines designed to assist the federal
      banking agencies in identifying and addressing potential safety and soundness
      concerns before capital becomes impaired. The guidelines set forth operational
      and managerial standards relating to:





·
            internal
                controls, information systems and internal audit
                systems


·
            loan
                documentation


·
            credit
                underwriting


·
            asset
                growth


·
            earnings


·
            compensation,
                fees and benefits.





In
      addition, the federal banking agencies have also adopted safety and soundness
      guidelines with respect to asset quality and earnings standards. These
      guidelines provide six standards for establishing and maintaining a system
      to
      identify problem assets and prevent those assets from deteriorating. Under
      these
      standards, an insured depository institution should:





·
            conduct
                periodic asset quality reviews to identify problem
                assets


·
            estimate
                the inherent losses in problem assets and establish reserves that
                are
                sufficient to absorb estimated
                losses


·
            compare
                problem asset totals to capital


·
            take
                appropriate corrective action to resolve problem
                assets


·
            consider
                the size and potential risks of material asset
                concentrations


·
            provide
                periodic asset quality reports with adequate information for management
                and the board of directors to assess the level of asset
                risk.





These
      guidelines also set forth standards for evaluating and monitoring earnings
      and
      for ensuring that earnings are sufficient for the maintenance of adequate
      capital and reserves.





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, 2006 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.




22


***Pending
      Legislation***





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.




**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 common stockholders' equity, noncumulative perpetual
      preferred stock, and a limited amount of cumulative perpetual preferred stock,
      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, 2006, our company's capital ratios were as follows:


·
            Tier
                I leverage ratio was 11.42%


·
            Tier
                I risk-based ratio was 10.93%


·
            Total
                risk-based ratio was 12.40%





As
      of
      December 31, 2006, our bank’s capital ratios were as follows:


·
            Tier
                I leverage ratio was 11.16%


·
            Tier
                I risk-based ratio was 10.66%


·
            Total
                risk-based ratio was 11.67%





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. In October 2006, the U.S. federal
      banking agencies issued a notice of proposed rulemaking for comment to implement
      Basel II for U.S. banks with certain differences from the international Basel
      II
      framework and which would not be fully in effect for U.S. banks until 2012.
      Further, the U.S. banking agencies propose to retain the minimum leverage
      requirement and prompt corrective action regulatory standards. In December
      2006,
      the federal banking agencies issued another notice of proposed rulemaking for
      comment, referred to as Basel IA, that proposed alternative capital requirements
      for smaller U.S. banks which may be negatively impacted competitively by certain
      provisions of Basel II. Additional guidance on Basel II issued in February
      2007
      stated the agencies' expectation that to determine the extent to which banks
      should hold capital in excess of regulatory minimum levels, examiners would
      look
      at the combined implications of a bank's compliance with qualification
      requirements for regulatory risk-based capital standards, the quality and
      results of the bank's internal capital adequacy assessment process, and the
      examiners' assessment of the bank's risk profile and capital position. At this
      time the impact that proposed changes in capital requirements may have on the
      cost and availability of different types of credit and the potential compliance
      cost to us of implementing Basel II or Basel IA, as applicable, are
      uncertain.





23


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, 2006.





**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. Institutions assigned
      to
      higher-risk classifications (that is, institutions that pose a greater risk
      of
      loss to their respective deposit insurance funds) pay assessments at higher
      rates than institutions that pose a lower risk. An institution's risk
      classification is assigned based on its capital levels and the level of
      supervisory concern the institution poses to the regulators. In addition, the
      FDIC can impose special assessments in certain instances.




We
      pay
      an assessment fee to the FDIC for deposit insurance protection. This
      assessment fee is required for all FDIC-insured banks 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 current range if DIF assessments
      are
      (not including FICO bond assessments) between 0.05% and 0.43% per $100 of
      domestic deposits. The rate for our bank was 0.0% for 2006, 2005, and 2004.
      The
      assessment for the fourth quarter of 2006 was 1.24 basis points for each $100
      of
      assessable deposits. We paid $98 thousand of FDIC assessments in 2006, $75
      thousand in 2005, and $58 thousand in 2004.





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.





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 will be effective on January
      1, 2007 and will vary between five and seven cents per $100 of domestic
      deposits. We anticipate an increase in the amount we will pay for deposit
      insurance of approximately $295 thousand during 2007. The Reform Act provides
      for the following changes:





24


·
            Merging
                the Bank Insurance Fund (BIF) and the Savings Association Insurance
                Fund
                (SAIF) into a new fund, the Deposit Insurance Fund (DIF). This change
                was
                made effective March 31, 2006.


·
            Increasing
                the coverage limit for retirement accounts to $250,000 and indexing
                the
                coverage limit for retirement accounts to inflation as with the general
                deposit insurance coverage limit. This change was made effective
                April 1,
                2006.


·
            Establishing
                a range of 1.15 percent to 1.50 percent within which the FDIC Board
                of
                Directors may set the Designated Reserve Ratio (DRR).


·
            Allowing
                the FDIC to manage the pace at which the reserve ratio varies within
                this
                range.





1.
            If
                the reserve ratio falls below 1.15 percent—or is expected to within 6
                months—the FDIC must adopt a restoration plan that provides that the DIF
                will return to 1.15 percent generally within 5 years.


2.
            If
                the reserve ratio exceeds 1.35 percent, the FDIC must generally dividend
                to DIF members half of the amount above the amount necessary to maintain
                the DIF at 1.35 percent, unless the FDIC Board, considering statutory
                factors, suspends the dividends.


3.
            If
                the reserve ratio exceeds 1.5 percent, the FDIC must generally dividend
                to
                DIF members all amounts above the amount necessary to maintain the
                DIF at
                1.5 percent.





·
            Eliminating
                the restrictions on premium rates based on the DRR and granting the
                FDIC
                Board the discretion to price deposit insurance according to risk
                for all
                insured institutions regardless of the level of the reserve ratio.


·
            Granting
                a one-time initial assessment credit (of approximately $4.7 billion)
                to
                recognize institutions' past contributions to the fund.




**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
      Federal Reserve, 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
      the 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 Securities and Exchange
      Commission (" 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.





25


**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.




**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 June 2002, our company formed Temecula Valley
      Statutory Trust I, a Connecticut statutory trust, for the purpose of issuing
      trust preferred securities. 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.





**Employees**





As
      of
      December 31, 2006, we had 317 employees (312 full time equivalent), of
      which 299 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.





26


**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, and 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 "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, however,
      we
      are in the process of revising our website to provide this information directly
      on our 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 or the amendments to those reports may be obtained free
      of
      charge by contacting Donald Pitcher at (951)939-3736.




**ITEM
      1A:****RISK
      FACTORS**





**Risks
      Related to Our Business and Operations**




***Our
      success has been built upon significant and profitable growth and we may not
      be
      able to sustain our profitable growth or our rate of growth or be able to
      support our growth, any of which events will adversely affect our profits and
      results of operations.***





We
      have
      experienced significant growth from $606.8 million in total assets and $534.8
      million in total deposits at December 31, 2004 to $1.24 billion in total assets
      and $1.08 billion in total deposits at December 31, 2006. We expect to continue
      to experience growth in assets, deposits, and scale of operations. However,
      we
      do expect our levels of construction lending to taper off and intend to replace
      this business by increasing our commercial and industrial (“C&I”) loan
      portfolios. If the margins in C&I business are less than with construction
      lending, if our growth declines or if we do not manage our growth effectively,
      we will become less profitable, which will adversely affect our business and
      prospects.





Our
      growth also subjects us to increased capital and operating needs. We must
      continue to recruit experienced individuals with the skills and experience
      to
      manage our growing business lines, but who may have no prior history with us.
      Our historical growth has caused us to update our policies and procedures in
      response to this growth, and our plans for continued growth will continue to
      place a significant strain on our personnel, systems, and resources. We cannot
      guarantee that our policies will be adequate or that we will be able to recruit
      and train qualified individuals to implement our business strategy in a timely,
      cost effective and efficient manner.





***Our
      recent operating results may not be indicative of our future operating
      results.*** **





We
      may
      not be able to sustain our growth. Various factors, such as our increased size,
      economic conditions, decreased construction and SBA loan demand, governmental,
      regulatory and legislative considerations, competition and the ability to find
      and retain people that can make our community-focused operating model
      successful, may impede our ability to expand our market presence. If we
      experience a significant decrease in our growth rate, our results of operations
      and financial condition may be adversely affected.





***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.***





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
      94%
      and 95% of our loan portfolio at December 31, 2006 and December 31, 2005,
      respectively. Our markets have experienced a sharp increase in real estate
      values in recent years, in part as the result of historically low interest
      rates. During 2006, real estate markets in California and elsewhere experienced
      a slowdown in appreciation and in some cases a modest depreciation. A 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. Acts of nature, including
      earthquakes and floods, which may cause uninsured damage and other loss of
      value
      to real estate that secures these loans, may also adversely affect our financial
      condition.





27


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.





In
      December 2006, banking regulators issued final guidance regarding high
      concentrations of real estate loans within bank lending portfolios. The guidance
      establishes commercial real estate (“CRE”) concentration thresholds as criteria
      for examiners to identify CRE concentration that may warrant further analysis.
      If we do not have appropriate risk management policies and practices in place,
      as a result of the final guidance, we may be subject to enhanced regulatory
      scrutiny and higher capital maintenance requirements.





***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 50% and
      51%
      of our lending portfolio was classified as real estate construction loans as
      of
      December 31, 2006 and December 31, 2005, 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 continued strength of 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 decline in the demand for new
      housing in these communities, it is expected that the demand for construction
      loans would decline, our liquidity would substantially increase and our net
      income would 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
      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.





28


***Our
      new SBA purchase program is subject to governmental and management changes
      that
      could affect its success and operations.***





In
      April
      2006, we began purchasing participations in unguaranteed portions of SBA 7(a)
      loans. At December 31, 2006, we have $120.3 million in outstanding
      participation balances. If the SBA program was discontinued or the SBA decided
      to stop funding the program, the participation purchase program would be
      substantially reduced and ultimately eliminated. Additionally, the participation
      purchase program is highly dependent upon a management team experienced in
      the
      program. If our management from this program were to terminate employment with
      us, we could have a difficult time replacing them with qualified personnel
      and
      this may limit our growth and adversely affect the program and our
      results.




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





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





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


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


·
            the
                credit history of a particular
                borrower;


·
            changes
                in economic and industry conditions;
                and


·
            the
                duration of the loan.





Our
      bank’s loan losses as a percentage of net loans outstanding and loans
      held-for-sale was 1.10% as of December 31, 2006 and 1.20% as of December 31,
      2005 and 2004. The allowance for loan losses as a percentage of net loans
      outstanding, excluding loans held-for-sale, was 1.29% as of December 31, 2006,
      1.35% as of December 31 2005, and 1.29% as of December 31, 2004. Regulatory
      agencies, as an integral part of their examination process, review our bank’s
      loans and allowance for loan losses. Although management believes the level
      of
      our loan loss allowance is adequate to absorb probable losses in our loan
      portfolio, management cannot predict these 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 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 is reasonable, significant fluctuations in interest
      rates may adversely affect our business, financial condition and result of
      operations.





29


While
      the
      federal funds rate and other short-term market interest rates, which we use
      to
      guide our deposit pricing, have increased, intermediate and long-term market
      interest rates, which we use to guide our loan pricing, have not increased
      proportionately. This has led to a flattening of the market yield curve, which
      has even inverted recently as short-term rates have exceeded long-term rates
      over an intermediate maturity horizon. If short-term interest rates continue
      to
      rise so that the yield curve remains relatively flat or inverts further, we
      would expect that our net interest spread and
      net
      interest margin would compress, which would hurt our net interest
      income.




Our
      net
      interest margin has ranged from a low of 5.69% to a high of 6.78% for the years
      ended December 31, 2002 to 2006. We are asset sensitive, which means that our
      assets reprice faster than our liabilities. Thus, in an increasing interest
      rate
      environment the net interest margin will generally increase and in a declining
      interest rate environment the net interest margin will generally decline.
      Beginning in June 2006, when the short-term Fed Fund rates stopped increasing,
      our net interest margin began to slightly compress due to the repricing at
      maturity of longer term, lower rate time deposits.





In
      addition, the value of our SBA servicing asset and SBA I/O strip receivable,
      which totaled $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. 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 our market share 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.





***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.





***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. The regulations impose
      significant limitations on operations, and may change at any time, possibly
      causing results to vary significantly from past results. Government policy
      and
      regulation, particularly as implemented through the Federal Reserve System,
      significantly affect our credit conditions.





30


***Our
      policies and procedures for minimizing loan losses may not fully protect us,
      particularly when the economy is weak.***





Some
      of
      our borrowers and guarantors may fail to perform their obligations as required
      by the terms of their loans, which could result in larger than expected losses.
      This risk increases when the economy and the real estate markets are weak.
      As a
      result of our growth, we have periodically modified our underwriting and credit
      policies, and loan monitoring procedures, including the establishment and
      monitoring of our allowance for loan losses. Management believes these policies
      and practices are reasonable and should minimize loan losses by assessing the
      likelihood of nonperformance, tracking loan performance, and diversifying the
      credit portfolio. However, these policies and procedures may not be adequate
      to
      prevent unexpected losses that could adversely affect our results of
      operations.




*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
      geographic concentration may adversely affect our results of operations if
      business conditions in our market area decline.***





If
      SBA
      lending is excluded, our operations are located almost entirely in California,
      with close to 100% of our loan portfolio as of December 31, 2006 derived from
      California operations. Due to this geographic concentration, our results depend
      largely upon California economic and business conditions and real estate values.
      Deterioration in economic and business conditions and real estate values in
      our
      market area could adversely affect the quality of our loan portfolio and the
      demand for our products and services, which in turn may adversely affect our
      results of operations to a greater extent than if our operations were
      geographically diverse. Even if the economy remains healthy, a sustained
      downturn in California real estate values would adversely affect our results
      of
      operations.





***Our
      growth may require us to raise additional capital in the future, but that
      capital may not be available when needed.***





We
      are
      required by regulatory authorities to maintain adequate levels of capital to
      support our operations. We anticipate that our capital levels following the
      private placement offering in November 2006 will satisfy our regulatory
      requirements for at least the next 12 months. We may at some point, however,
      need to raise additional capital to support our continued growth, particularly
      if the regulatory authorities pass legislation to increase our capital
      requirements. Our ability to raise additional capital will depend, in part,
      on
      conditions in the capital markets at that time, which are outside of our
      control. Accordingly, we cannot assure you of our ability to raise additional
      capital, if needed, on terms acceptable to us or at all. If we cannot raise
      additional capital when needed, our ability to further expand our operations
      could be adversely affected. In addition, if we decide to raise additional
      equity capital, your interest could be diluted.





***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.





31


**Risks
      Related to an Investment in Our Common Stock**





***We
      may issue additional shares of common stock or derivative securities that will
      dilute the percentage ownership interest of existing shareholders and may dilute
      the book value per share of our common stock and adversely affect the terms
      on
      which we may obtain additional capital.***





Our
      authorized capital includes 40,000,000 shares of common stock. At December
      31,
      2006, we have 10,586,659 shares of common stock outstanding, and have reserved
      for issuance 1,413,398 shares underlying options that are or may become
      exercisable at an average price of $9.36 per share. Our board generally has
      the
      authority, without action by or vote of the shareholders, to issue all or part
      of any authorized but unissued shares of common stock for any corporate purpose,
      including issuance of equity-based incentives under or outside of our stock
      option plans. We may seek equity capital in the future as we develop our
      business and expand our operations. Any issuance of additional shares of common
      stock or derivative securities will dilute the percentage ownership interest
      of
      our shareholders and may dilute the book value per share of our common stock.


***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.





***Volatility
      of our stock price may result in losses to our investors and litigation against
      us.***





Stock
      price volatility may make it more difficult for you to sell our securities
      when
      you want and at prices you find attractive. Our stock price can fluctuate
      significantly in response to a variety of factors, including, among other
      things:





·
            Actual
                or anticipated variations in quarterly results of
                operations;


·
            Recommendations
                by securities analysts;


·
            Operating
                and stock price performance of other companies that investors deem
                comparable to our company;


·
            News
                reports relating to trends, concerns and other issues in the financial
                services industry; and


·
            Perceptions
                in the marketplace regarding us and/or our
                competitors.





Moreover,
      in the past, securities class action lawsuits have been instituted against
      a
      company following periods of volatility in the market price of its securities.
      We could in the future be the target of similar litigation. Securities
      litigation could result in substantial costs and divert management’s attention
      and resources from our normal business.





***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, 2006, we had outstanding options to purchase 1,413,398 shares
      of
      our common stock at a weighted average exercise price of $9.36 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.





***Our
      ability to pay cash dividends is limited, and we may be unable to pay future
      dividends even if we desire to do so.***





Since
      our
      inception, our holding company has not paid any cash dividends on shares of
      its
      common stock, and currently it does not intend to pay cash dividends. Even
      if
      our holding company eventually decides to pay cash dividends, its ability to
      do
      so may be limited by regulatory restrictions, by our bank’s ability to pay cash
      dividends to our holding company and by our need to maintain sufficient capital
      to support our operations. The ability of our bank to pay cash dividends to
      our
      holding company is limited by its obligations to maintain sufficient capital
      and
      by other restrictions on its cash dividends that are applicable to California
      state banks and banks that are regulated by the FDIC. If our holding company
      does not satisfy these regulatory requirements, it will be unable to pay cash
      dividends on its common stock.





32


***Our
      common stock is not an insured deposit and therefore is subject to risk of
      loss.***





Our
      common stock is not a bank deposit and, therefore, is not insured against loss
      by the FDIC, any other deposit insurance fund or by any other public or private
      entity. Investment in our securities is inherently risky for the reasons
      described in this “Risk Factors” section and is subject to the same market
      forces that affect the price of securities in any company as well as other
      factors which affect the stock of financial services companies in general and
      of
      our company in particular.


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 ten 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,
      2006, 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 $5.5 million, with lease expiration dates ranging
      from
      2007 to 2014, exclusive of renewal options.





At
      December 31, 2006, our consolidated investment in premises and equipment, net
      of
      accumulated depreciation and amortization, totaled $5.5 million. Total occupancy
      expense, exclusive of rental payments and furniture and equipment expense was
      $3.0 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, 2006, 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.





**ITEM
      4:****SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY HOLDER**





No
      matters were submitted to a vote of security holders during the fourth quarter
      of 2006.




33


**PART
      II**




**ITEM 5:****MARKET
      FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES
      OF EQUITY SECURITIES**




**Trading
      Information**





Our
      company’s common stock is listed on The NASDAQ Global Select Market (and was
      previously quoted, beginning January 29, 2005, on the NASDAQ National Market)
      under the symbol TMCV. Prior to July 29, 2005, our common stock was quoted
      on
      the Over-the-Counter Bulletin Board (OTC) under the symbol TMCV.OB. As reported
      by the NASDAQ Global Select Market, information concerning the range of high
      and
      low per share bid prices before July 29, 2005 and the high and low per share
      closing sale prices for our common stock thereafter for the periods set forth
      below. The quotations before July 29, 2005 below reflect inter-dealer prices
      without retail mark-up, mark-down or commission and may not necessarily
      represent actual transactions.


2006
            
            2005
            
            2005NASDAQ
                Global Select Market
            
            OTC
                Bulletin BoardQuarter
                Ended
            
            High
            Low
            
            High
            Low
            
            High
            LowMarch
                31
            
            $23.92
            $19.16
            
            N/A
            N/A
            
            $18.50
            $16.60June
                30
            
            $24.00
            $19.85
            
            N/A
            N/A
            
            $22.00
            $16.80September
                30
            
            $25.00
            $19.85
            
            $25.95
            $19.16
            
            N/A
            N/ADecember
                31
            
            $23.86
            $20.15
            
            $24.50
            $19.16
            
            N/A
            N/A




The
      foregoing reflects information available to our company and does not necessarily
      include all trades in our company’s common stock during the periods
      indicated.





As
      of March 8, 2007, the closing sale
      price of our company’s stock, as reported by The NASDAQ Global Select Market was
      $22.90. As of December 31, 2006, there were approximately 444 record holders
      of
      our company’s common stock and directors and executive officers owned
      approximately 13.8% of our outstanding shares.





**Issuance
      of Common Stock**




On
      November 21, 2006, we completed a private placement of 1,400,569 shares of
      common stock, no par value, to institutional and individual investors, including
      employees, officers and directors of our company or our bank, and our company's
      employee stock ownership plan (ESOP). The purchase price was $21.31 per share
      for the 64,139 shares sold to 19 employees, officers and directors of our
      company or our bank, and our ESOP. The purchase price for the remaining
      1,336,430 shares sold to other investors was $19.00 per share. We paid
      approximately $0.95 per share commission to our placement agents on shares
      sold
      in this private placement, although we paid a reduced commission of
      approximately $0.53 per share on 64,139 shares sold to our employees, officers,
      directors and our ESOP. The sale resulted in net proceeds of approximately
      $25.1 million. The proceeds we received in the private placement will be used
      to
      fund our growth to the extent growth in retained earnings is insufficient to
      satisfy regulatory requirements for additional capital, if necessary, in
      connection with loan concentrations, and to possibly pay down up to $7.0 million
      in higher cost trust preferred securities.





The
      placement was made under the exemption from registration provided by Section
      4(2) of the Securities Act of 1933, as amended, and Rule 506 of Regulation
      D
      thereunder, to accredited and sophisticated purchasers.





A
      registration statement covering the resale of the shares of common stock issued
      in the placement under Registration No. 333-139908 became effective on February
      21, 2007.





34


**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.





The
      Federal Reserve has broad authority to prohibit the payment of dividends by
      our
      company depending upon the condition of each entity within the corporate
      structure. In addition, the future payment of cash dividends will generally
      depend, subject to regulatory restraints, upon our company’s earnings during any
      period, and the assessment by our Board of the capital requirements, our company
      and other factors, including the maintenance of the allowance for loan losses
      at
      our bank.





No
      cash
      dividends were paid by our bank prior to the formation of our company in 2002
      and none have been paid by our company since its formation in 2002.




Since
      1998, there have been three two-for-one stock splits to shareholders, the last
      one declared in December 2003. Whether or not stock 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. For further discussion of
      dividends, see "MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
      RESULTS OF OPERATIONS, - Financial Condition - Capital".




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, 2001 though December 31, 2006. 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
                  Ending******Index***
              **12/31/01**
              **12/31/02**
              **12/31/03**
              **12/31/04**
              **12/31/05**
              **12/31/06**Temecula
                  Valley Bancorp Inc.
              100.00
              132.46
              282.72
              371.73
              476.86
              492.15NASDAQ
                Composite
              100.00
              68.76
              103.67
              113.16
              115.57
              127.58NASDAQ
                Bank
              100.00
              106.95
              142.29
              161.73
              158.61
              180.53SNL
                Bank and Thrift Index
              100.00
              93.96
              127.39
              142.66
              144.89
              169.30


**ITEM
      6:****SELECTED
      FINANCIAL DATA**





The
      following table represents selected financial information for the five years
      ended December 31, 2006 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.


35





**TEMECULA
                VALLEY BANCORP INC.****Selected
                Financial Data****For
                the Year Ended December 31,****2006**
            
            **2005**
            
            **2004**
            
            **2003**
            
            **2002****Income
                Statement:**
            (dollars
                and shares in thousands, except per share data)Interest
                income
            $
            94,229
            
            
            $
            58,125
            
            
            $
            33,615
            
            
            $
            23,891
            
            
            $
            16,509Interest
                expense
            
            34,449
            
            
            
            14,584
            
            
            
            6,415
            
            
            
            4,947
            
            
            
            3,124Net
                interest income
            
            59,780
            
            
            
            43,541
            
            
            
            27,200
            
            
            
            18,944
            
            
            
            13,385Provision
                for loan losses
            
            3,650
            
            
            
            2,897
            
            
            
            3,821
            
            
            
            1,022
            
            
            
            2,460Net
                interest income
              after
                provision for loan losses
            
            56,130
            
            
            
            40,644
            
            
            
            23,379
            
            
            
            17,922
            
            
            
            10,925Non-interest
                income
            
            19,444
            
            
            
            23,822
            
            
            
            28,698
            
            
            
            24,481
            
            
            
            17,942Non-interest
                expense
            
            46,991
            
            
            
            40,627
            
            
            
            33,963
            
            
            
            29,121
            
            
            
            21,801Income
                before income taxes
            
            28,583
            
            
            
            23,839
            
            
            
            18,114
            
            
            
            13,282
            
            
            
            7,066Provision
                for income taxes
            
            11,663
            
            
            
            9,886
            
            
            
            7,536
            
            
            
            5,428
            
            
            
            2,875Net
                income
            $
            16,920
            
            
            $
            13,953
            
            
            $
            10,578
            
            
            $
            7,854
            
            
            $
            4,191**Per
                Share Data:**Basic
                earnings per share
            $
            1.83
            
            
            $
            1.58
            
            
            $
            1.24
            
            
            $
            1.00
            
            
            $
            0.57Diluted
                earnings per share
            $
            1.73
            
            
            $
            1.46
            
            
            $
            1.13
            
            
            $
            0.89
            
            
            $
            0.50Average
                common shares outstanding
            
            9,235
            
            
            
            8,846
            
            
            
            8,503
            
            
            
            7,824
            
            
            
            7,373Average
                common shares (dilutive)
            
            9,798
            
            
            
            9,589
            
            
            
            9,364
            
            
            
            8,862
            
            
            
            8,370Book
                value per share
            $
            9.75
            
            
            $
            6.54
            
            
            $
            4.90
            
            
            $
            3.64
            
            
            $
            2.63Equity
                shares-beginning balance
            
            8,898
            
            
            
            8,753
            
            
            
            8,152
            
            
            
            7,447
            
            
            
            7,326Warrants
                - Shares Issued
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            324
            
            
            
            67Options
                - Shares Issued
            
            288
            
            
            
            145
            
            
            
            601
            
            
            
            381
            
            
            
            54Private
                Placement Stock offering
            
            1,401
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Equity
                shares-ending balance
            
            10,587
            
            
            
            8,898
            
            
            
            8,753
            
            
            
            8,152
            
            
            
            7,447**Balance
                Sheet Data:**Assets
            $
            1,238,189
            
            
            $
            868,988
            
            
            $
            606,828
            
            
            $
            431,212
            
            
            $
            310,506Loans
                (including loans held-for-sale)
            
            1,142,693
            
            
            
            753,246
            
            
            
            530,196
            
            
            
            360,749
            
            
            
            271,426Other
                Real Estate Owned
            
            1,255
            
            
            
            2,111
            
            
            
            303
            
            
            
            485
            
            
            
            -Fed
                Funds Sold
            
            18,180
            
            
            
            33,200
            
            
            
            16,800
            
            
            
            21,400
            
            
            
            -FRB/FHLB
                Stock
            
            1,996
            
            
            
            3,099
            
            
            
            2,378
            
            
            
            1,145
            
            
            
            1,460Deposits
            
            1,081,501
            
            
            
            742,432
            
            
            
            534,767
            
            
            
            383,487
            
            
            
            269,321FHLB
                advances
            
            -
            
            
            
            30,000
            
            
            
            -
            
            
            
            -
            
            
            
            10,000Junior
                Subordinated Debt
            
            41,240
            
            
            
            28,868
            
            
            
            20,620
            
            
            
            12,372
            
            
            
            7,217Stockholders’
                equity
            
            103,263
            
            
            
            58,181
            
            
            
            42,903
            
            
            
            29,683
            
            
            
            19,616ALLL
                beginning balance
            $
            9,039
            
            
            $
            6,362
            
            
            $
            3,608
            
            
            $
            3,017
            
            
            $
            1,239Charge
                offs
            
            (381
            )
            
            
            (540
            )
            
            
            (1,097
            )
            
            
            (505
            )
            
            
            (708
            )Recoveries
            
            214
            
            
            
            320
            
            
            
            30
            
            
            
            74
            
            
            
            26Provision
                for loan losses
            
            3,650
            
            
            
            2,897
            
            
            
            3,821
            
            
            
            1,022
            
            
            
            2,460ALLL
                ending balance
            $
            12,522
            
            
            $
            9,039
            
            
            $
            6,362
            
            
            $
            3,608
            
            
            $
            3,017Non-performing
                loans
            $
            19,124
            
            
            $
            7,951
            
            
            $
            11,799
            
            
            $
            6,765
            
            
            $
            1,908Government
                guaranteed portion
            
            (10,335
            )
            
            
            (6,514
            )
            
            
            (8,140
            )
            
            
            (5,269
            )
            
            
            (1,078
            )Net
                non-performing loans
            $
            8,789
            
            
            $
            1,437
            
            
            $
            3,659
            
            
            $
            1,496
            
            
            $
            830SBA
                7(a) participation sold - period end
            $
            476,512
            
            
            $
            486,710
            
            
            $
            421,529
            
            
            $
            287,346
            
            
            $
            168,164Other
                participations sold
            
            3,550
            
            
            
            16,489
            
            
            
            18,772
            
            
            
            18,906
            
            
            
            8,911Total
                participation sold - period end
            $
            480,062
            
            
            $
            503,199
            
            
            $
            440,301
            
            
            $
            306,252
            
            
            $
            177,075





36





**TEMECULA
                VALLEY BANCORP INC.****Selected
                Financial Data****For
                the Year Ended December 31,****2006**
            
            **2005**
            
            **2004**
            
            **2003**
            
            **2002****Selected
                Ratios:**
            (dollars
                and shares in thousands)Return
                on average assets
            
            1.64
            %
            
            
            1.91
            %
            
            
            2.00
            %
            
            
            2.04
            %
            
            
            1.69
            %Return
                on average equity
            
            23.89
            %
            
            
            27.71
            %
            
            
            28.94
            %
            
            
            31.84
            %
            
            
            24.34
            %Income
                tax rate
            
            40.80
            %
            
            
            41.47
            %
            
            
            41.60
            %
            
            
            40.90
            %
            
            
            40.70
            %Tier
                I leverage ratio
            
            11.42
            %
            
            
            9.28
            %
            
            
            9.20
            %
            
            
            9.06
            %
            
            
            8.53
            %Tier
                I risk based ratio
            
            10.93
            %
            
            
            8.93
            %
            
            
            9.68
            %
            
            
            10.01
            %
            
            
            9.30
            %Total
                risk based ratio
            
            12.40
            %
            
            
            11.02
            %
            
            
            11.81
            %
            
            
            11.54
            %
            
            
            10.61
            %Average
                Equity / Average Assets
            
            6.88
            %
            
            
            6.90
            %
            
            
            6.93
            %
            
            
            6.45
            %
            
            
            6.95
            %Allowance
                for loan loss/net loans and loans held-for-sale
            
            1.10
            %
            
            
            1.20
            %
            
            
            1.20
            %
            
            
            1.00
            %
            
            
            1.11
            %Allowance
                for loan loss/net loans excluding loans held-for-sale
            
            1.29
            %
            
            
            1.35
            %
            
            
            1.29
            %
            
            
            1.05
            %
            
            
            1.21
            %Allowance
                for loan loss/net nonperforming loans
            
            142.46
            %
            
            
            629.10
            %
            
            
            173.88
            %
            
            
            256.71
            %
            
            
            363.06
            %Loan
                to deposit ratio
            
            105.66
            %
            
            
            101.46
            %
            
            
            99.15
            %
            
            
            94.07
            %
            
            
            100.78
            %Average
                interest earning assets/average total assets
            
            91.21
            %
            
            
            87.96
            %
            
            
            86.09
            %
            
            
            86.34
            %
            
            
            86.40
            %Investment
                yield (includes FRB/FHLB)
            
            5.03
            %
            
            
            3.30
            %
            
            
            1.37
            %
            
            
            1.07
            %
            
            
            1.54
            %Loan
                yield
            
            10.12
            %
            
            
            9.12
            %
            
            
            7.48
            %
            
            
            7.45
            %
            
            
            7.99
            %Total
                interest-bearing assets
            
            10.03
            %
            
            
            9.05
            %
            
            
            7.39
            %
            
            
            7.16
            %
            
            
            7.70
            %Interest-bearing
                deposit cost
            
            4.20
            %
            
            
            2.64
            %
            
            
            1.66
            %
            
            
            1.82
            %
            
            
            1.89
            %Borrowing
                cost
            
            7.41
            %
            
            
            5.64
            %
            
            
            4.06
            %
            
            
            4.32
            %
            
            
            3.21
            %Net
                interest margin
            
            6.37
            %
            
            
            6.78
            %
            
            
            5.98
            %
            
            
            5.69
            %
            
            
            6.23
            %Net
                interest spread
            
            5.68
            %
            
            
            6.24
            %
            
            
            5.59
            %
            
            
            5.25
            %
            
            
            5.72
            %Efficiency
                ratio
            
            59.31
            %
            
            
            60.31
            %
            
            
            60.76
            %
            
            
            67.06
            %
            
            
            69.59
            %**SBA
                Loan Servicing:**SBA
                excess servicing asset
            $
            8,288
            
            
            $
            8,169
            
            
            $
            7,586
            
            
            $
            6,117
            
            
            $
            3,764SBA
                I/O strip receivable asset
            
            13,215
            
            
            
            22,068
            
            
            
            24,680
            
            
            
            20,496
            
            
            
            13,120Total
                SBA servicing asset
            $
            21,503
            
            
            $
            30,237
            
            
            $
            32,266
            
            
            $
            26,613
            
            
            $
            16,884SBA
                servicing-fee income
            $
            9,077
            
            
            $
            10,265
            
            
            $
            8,738
            
            
            $
            6,026
            
            
            $
            2,675SBA
                servicing-asset amortization
            
            (11,487
            )
            
            
            (7,492
            )
            
            
            (6,120
            )
            
            
            (4,234
            )
            
            
            (1,462
            )SBA
                servicing-guarantee fee to SBA
            
            (205
            )
            
            
            (135
            )
            
            
            (118
            )
            
            
            (99
            )
            
            
            (83
            )SBA
                servicing-net servicing income
            $
            (2,615
            )
            
            $
            2,638
            
            
            $
            2,500
            
            
            $
            1,693
            
            
            $
            1,130**Loan
                Sales:**SBA
                7A sales - guaranteed
            $
            114,589
            
            
            $
            108,912
            
            
            $
            146,881
            
            
            $
            129,813
            
            
            $
            108,213SBA
                7A guaranteed-sales gain
            
            5,948
            
            
            
            5,113
            
            
            
            8,795
            
            
            
            8,149
            
            
            
            6,042SBA
                7A sales - unguaranteed
            $
            20,556
            
            
            $
            37,011
            
            
            $
            35,365
            
            
            $
            19,209
            
            
            $
            12,573Unguaranteed
                SBA 7A sales gain
            
            3,443
            
            
            
            6,510
            
            
            
            6,361
            
            
            
            3,191
            
            
            
            2,094Mortgage
                loan sales
            $
            -
            
            
            $
            13,522
            
            
            $
            45,243
            
            
            $
            100,800
            
            
            $
            83,014Mortgage
                loan sales gain
            
            -
            
            
            
            285
            
            
            
            1,511
            
            
            
            3,568
            
            
            
            3,100SBA
                Broker referral income
            $
            3,056
            
            
            $
            2,492
            
            
            $
            2,506
            
            
            $
            2,845
            
            
            $
            1,972Mortgage
                Broker referral income
            
            1,258
            
            
            
            898
            
            
            
            963
            
            
            
            1,038
            
            
            
            908**Employee
                Related:**Full
                time employees
            
            299
            
            
            
            260
            
            
            
            229
            
            
            
            194
            
            
            
            181Part
                time employees
            
            18
            
            
            
            21
            
            
            
            16
            
            
            
            14
            
            
            
            18Full
                time equivalent employees
            
            312
            
            
            
            275
            
            
            
            238
            
            
            
            204
            
            
            
            194Salary
                continuation plan expense
            $
            654
            
            
            $
            723
            
            
            $
            1,085
            
            
            $
            531
            
            
            $
            267CSV
                life insurance balance
            $
            24,036
            
            
            $
            17,591
            
            
            $
            9,594
            
            
            $
            5,741
            
            
            $
            3,983CSV
                Life insurance income
            $
            888
            
            
            $
            605
            
            
            $
            378
            
            
            $
            250
            
            
            $
            176CSV
                Life insurance expense
            
            (143
            )
            
            
            (98
            )
            
            
            (61
            )
            
            
            (45
            )
            
            
            (25
            )Net
                Life insurance income
            $
            745
            
            
            $
            507
            
            
            $
            317
            
            
            $
            205
            
            
            $
            151








37


The
      following table sets forth our company’s unaudited results of operations for the
      four quarters ended in 2006 and 2005. The only component of other comprehensive
      income 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.





For
                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
            
            
            $
            0.43For
                the Quarter Ended in 2005March
                31,
            
            
            June
                30,
            
            
            September
                30,
            
            
            December
                31,Interest
                income
            $
            11,411
            
            
            $
            13,454
            
            
            $
            15,352
            
            
            $
            17,908Interest
                expense
            
            (2,378
            )
            
            
            (3,179
            )
            
            
            (4,051
            )
            
            
            (4,976
            )Net
                interest income
            
            9,033
            
            
            
            10,275
            
            
            
            11,301
            
            
            
            12,932Provision
                for loan losses
            
            (839
            )
            
            
            (804
            )
            
            
            (346
            )
            
            
            (908
            )Non-interest
                income
            
            5,783
            
            
            
            7,465
            
            
            
            5,599
            
            
            
            4,975Non-interest
                expense
            
            (8,837
            )
            
            
            (10,180
            )
            
            
            (10,950
            )
            
            
            (10,660
            )Income
                before income tax expense
            
            5,140
            
            
            
            6,756
            
            
            
            5,604
            
            
            
            6,339Income
                tax expense
            
            (2,139
            )
            
            
            (2,813
            )
            
            
            (2,318
            )
            
            
            (2,616
            )Net
                income
            $
            3,001
            
            
            $
            3,943
            
            
            $
            3,286
            
            
            $
            3,723Total
                comprehensive income
            $
            4,697
            
            
            $
            3,815
            
            
            $
            2,270
            
            
            $
            3,843Basic
                earnings per share
            $
            0.34
            
            
            $
            0.45
            
            
            $
            0.37
            
            
            $
            0.42Diluted
                earnings per share
            $
            0.32
            
            
            $
            0.41
            
            
            $
            0.34
            
            
            $
            0.39








38


**ITEM 7:****MANAGEMENT
      DISCUSSION AND ANALYSIS OF 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 Annual
      Report.*





**Results
      of Operations**





***Net
      Income***





Our
      net
      income and basic and diluted earnings per share for the years ended December
      31,
      2006, 2005, and 2004 are as follows:





·
            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.


·
            For
                2004, net income was $10.6 million, or $1.24 per basic share and
                $1.13 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
      $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. We sold $108.9 million of the guaranteed portion
      and
      $37.0 million of the unguaranteed portion of SBA 7(a) loans in 2005, which
      added
      $5.1 million and $6.5 million, respectively, to revenue, and in 2004 we sold
      $146.9 million of the guaranteed portion and $35.4 million, which added $8.8
      million and $6.4 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, 2006, 2005, and 2004 are as follows:





·
            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%.


·
            For
                2004, return on average assets was 2.00%; return on average equity
                was
                28.94%.





Due
      to
      increasing interest rates, mortgage loan activity slowed considerably in 2004
      and remained at subdued levels in 2005 and 2006. SBA 7(a) guaranteed loan sales
      for 2006 were $114.6 million, compared to $108.9 million in 2005, and $146.9
      million in 2004.




***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.





Net
      interest income was $59.8 million in 2006, compared to $43.5 million in 2005,
      and $27.2 million in 2004. 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 6.37% in 2006, compared to 6.78% in 2005,
      and
      5.98% in 2004. 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.
      Although the yield on interest-earning assets increased by 98 basis points
      for
      2006, the yield on interest-bearing liabilities increased by 154 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, 2006,
      2005, and 2004:





39


·
            Loans
                produced a yield of 10.12% in 2006, 9.12% in 2005, and 7.48% in 2004.
                The
                increase in loan yields has been the result of an increasing interest
                rate
                environment.


·
            Yield
                on investments, Federal Funds Sold and U.S. Treasuries, increased
                to 5.03%
                in 2006, compared to 3.30% in 2005, and 1.37% in 2004. The increase
                in
                investment yields is a result of an increase in average Federal Funds
                Sold
                and an increase in interest rates.


·
            Total
                interest-earning assets yielded 10.03% in 2006, 9.05% in 2005, and
                7.39%
                in 2004.


·
            Cost
                of interest-bearing deposits increased to 4.20% in 2006, compared
                to 2.64%
                in 2005, and 1.66% in 2004. The increase is a result of the growth
                in
                higher rate interest-bearing deposits compared to the other
                interest-bearing deposits, as well as the increasing interest rate
                environment.


·
            Cost
                of other borrowings, FHLB advances, and junior subordinated debt
                borrowings, increased to 7.41% in 2006, compared to 5.64% in 2005
                and
                4.06% in 2004. Contributing to the increase in the cost of borrowings
                was
                the increase in junior subordinated debt as well as the increasing
                interest rate environment.





Our
      goal
      is to maintain at least 90% of our assets as interest-earning assets. For 2006,
      our average interest-earning assets to total average assets were 91.21%,
      compared to 87.96% for 2005, and 86.09% for 2004. This ratio for 2005 and 2004
      remained 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.


40





**Average
                Balances with Rates Earned and Paid****Year
                ended December 31,****2006**
            
            **2005**
            
            **2004****Interest**
            
            **Average**
            
            
            
            
            
            **Interest**
            
            **Average**
            
            
            
            
            
            
            **Interest**
            
            **Average****Average**
            
            
            **Income/**
            
            **Interest**
            
            
            **Average**
            
            
            **Income/**
            
            **Interest**
            
            
            **Average**
            
            
            
            **Income/**
            
            **Interest****Balance**
            
            
            **Expense**
            
            **Rate**
            
            
            **Balance**
            
            
            **Expense**
            
            **Rate**
            
            
            **Balance**
            
            
            
            **Expense**
            
            **Rate****Assets**
            
            (
                dollars in thousands)Interest-bearing
                deposits
            
            $
            54
            
            
            $
            3
            
            5.56%
            
            $
            -
            
            
            $
            -
            
            0.00%
            
            $
            -
            
            
            $
            -
            
            0.00%Securities-HTM
                (1)
            
            
            381
            
            
            
            19
            
            4.99%
            
            
            203
            
            
            
            6
            
            2.96%
            
            
            168
            
            
            
            2
            
            1.19%Federal
                Funds Sold
            
            
            16,497
            
            
            
            829
            
            5.03%
            
            
            7,224
            
            
            
            239
            
            3.29%
            
            
            8,098
            
            
            
            111
            
            1.37%Total
                Investments
            
            
            16,932
            
            
            
            851
            
            5.03%
            
            
            7,427
            
            
            
            245
            
            3.30%
            
            
            8,266
            
            
            
            113
            
            1.37%Total
                Loans (2)
            
            
            922,264
            
            
            
            93,378
            
            10.12%
            
            
            634,731
            
            
            
            57,880
            
            9.12%
            
            
            446,493
            
            
            
            33,502
            
            7.48%Total
                Interest Earning Assets
            
            939,196
            
            
            
            94,229
            
            10.03%
            
            
            642,158
            
            
            
            58,125
            
            9.05%
            
            
            454,759
            
            
            
            33,615
            
            7.39%Allowance
                for Loan Loss
            
            
            (10,311
            )
            
            
            
            
            
            
            
            (7,606
            )
            
            
            
            
            
            
            
            (4,395
            )Cash
                & Due From Banks
            
            
            24,286
            
            
            
            
            
            
            
            
            25,385
            
            
            
            
            
            
            
            
            21,994Premises
                & Equipment
            
            
            5,173
            
            
            
            
            
            
            
            
            4,673
            
            
            
            
            
            
            
            
            2,820Other
                Assets
            
            
            71,310
            
            
            
            
            
            
            
            
            65,414
            
            
            
            
            
            
            
            
            53,061**Total
                Assets**
            
            $
            1,029,654
            
            
            
            
            
            
            
            $
            730,024
            
            
            
            
            
            
            
            $
            528,239**Liabilities
                and****Shareholders'
                Equity**Interest
                Bearing Demand
            
            $
            31,161
            
            
            
            47
            
            0.15%
            
            $
            32,791
            
            
            
            49
            
            0.15%
            
            $
            31,588
            
            
            
            45
            
            0.14%Money
                Market
            
            
            83,672
            
            
            
            2,727
            
            3.26%
            
            
            50,239
            
            
            
            912
            
            1.81%
            
            
            37,770
            
            
            
            456
            
            1.21%Savings
            
            
            31,685
            
            
            
            122
            
            0.39%
            
            
            38,010
            
            
            
            141
            
            0.37%
            
            
            40,699
            
            
            
            186
            
            0.46%Time
                Deposits under $100,000
            
            293,909
            
            
            
            13,876
            
            4.72%
            
            
            175,124
            
            
            
            5,555
            
            3.17%
            
            
            113,802
            
            
            
            2,425
            
            2.13%Time
                Deposits $100,000 or more
            
            315,346
            
            
            
            14,942
            
            4.74%
            
            
            194,496
            
            
            
            6,293
            
            3.24%
            
            
            112,964
            
            
            
            2,484
            
            2.20%Other
                Borrowings
            
            
            36,906
            
            
            
            2,735
            
            7.41%
            
            
            28,993
            
            
            
            1,634
            
            5.64%
            
            
            20,195
            
            
            
            819
            
            4.06%Total
                Interest Bearing Liabilities
            
            792,679
            
            
            
            34,449
            
            4.35%
            
            
            519,653
            
            
            
            14,584
            
            2.81%
            
            
            357,018
            
            
            
            6,415
            
            1.80%Non-interest
                Demand Deposits
            
            154,473
            
            
            
            
            
            
            
            
            151,447
            
            
            
            
            
            
            
            
            128,670Other
                Liabilities
            
            
            11,683
            
            
            
            
            
            
            
            
            8,569
            
            
            
            
            
            
            
            
            6,003Shareholders'
                Equity
            
            
            70,819
            
            
            
            
            
            
            
            
            50,355
            
            
            
            
            
            
            
            
            36,548**Total
                Liabilities and****Shareholders'
                equity**
            
            $
            1,029,654
            
            
            
            
            
            
            
            $
            730,024
            
            
            
            
            
            
            
            $
            528,239**Net
                Interest Income**
            
            
            
            
            
            $
            59,780
            
            
            
            
            
            
            
            $
            43,541
            
            
            
            
            
            
            
            $
            27,200**Interest
                Spread (3)**
            
            
            
            
            
            
            
            
            5.68%
            
            
            
            
            
            
            
            
            6.24%
            
            
            
            
            
            
            
            
            5.59%**Net
                Interest Margin (4)**
            
            
            
            
            
            
            
            6.37%
            
            
            
            
            
            
            
            
            6.78%
            
            
            
            
            
            
            
            
            5.98%(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.









41


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 31,2006
            
            2005Assets
            
            
            Volume
            
            
            Rate
            
            
            Total
            
            
            Volume
            
            
            Rate
            
            
            TotalDue
                From Banks-Time
            $
            -
            
            
            $
            3
            
            
            $
            3
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -Securities-HTM
                (1)
            
            5
            
            
            
            8
            
            
            
            13
            
            
            
            -
            
            
            
            4
            
            
            
            4Federal
                Funds Sold
            
            306
            
            
            
            284
            
            
            
            590
            
            
            
            (12)
            
            
            
            140
            
            
            
            128Total
                Investments
            
            311
            
            
            
            295
            
            
            
            606
            
            
            
            (12)
            
            
            
            144
            
            
            
            132Total
                Loans (2)
            
            26,925
            
            
            
            8,573
            
            
            
            35,498
            
            
            
            14,980
            
            
            
            9,398
            
            
            
            24,378Total
                Interest Earning Assets
            $
            27,236
            
            
            $
            8,868
            
            
            $
            36,104
            
            
            $
            14,968
            
            
            $
            9,542
            
            
            $
            24,510Liabilities
                and Shareholders' EquityInterest
                Bearing Demand
            
            (2
            )
            
            
            (1
            )
            
            
            (3
            )
            
            
            1
            
            
            
            3
            
            
            
            4Money
                Market
            
            607
            
            
            
            1,209
            
            
            
            1,816
            
            
            
            151
            
            
            
            305
            
            
            
            456Savings
            
            
            (24
            )
            
            
            4
            
            
            
            (20
            )
            
            
            (12
            )
            
            
            (33
            )
            
            
            (45
            )Time
                Deposits under $100,000
            
            3,768
            
            
            
            4,554
            
            
            
            8,322
            
            
            
            1,306
            
            
            
            1,824
            
            
            
            3,130Time
                Deposits $100,000 or more
            3,909
            
            
            
            4,740
            
            
            
            8,649
            
            
            
            1,793
            
            
            
            2,016
            
            
            
            3,809Other
                Borrowings
            
            555
            
            
            
            546
            
            
            
            1,101
            
            
            
            447
            
            
            
            368
            
            
            
            815Total
                Interest Bearing Liabilities
            
            8,813
            
            
            
            11,052
            
            
            
            19,865
            
            
            
            3,686
            
            
            
            4,483
            
            
            
            8,169Net
                Interest Income
            $
            18,423
            
            
            $
            (2,184
            )
            
            $
            16,239
            
            
            $
            11,282
            
            
            $
            5,059
            
            
            $
            16,341(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 $3.7 million in 2006, $2.9 million in 2005, and $3.8 million
      in
      2004. The allowance, as a percentage of net loans outstanding, including loans
      held-for-sale, was 1.10% as of December 31, 2006 and 1.20% as of December 31,
      2005 and 2004. The allowance, as a percentage of net loans outstanding,
      excluding loans held-for-sale, was 1.29% as of December 31, 2006, 1.35% as
      of
      December 31, 2005, and 1.29% as of December 31, 2004. 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
      $19.1 million of nonperforming loans as of December 31, 2006, of which $10.3
      million was guaranteed by the SBA, compared to $8.0 million of nonperforming
      loans as of December 31, 2005, of which $6.5 million was SBA guaranteed, and
      $11.8 million of nonperforming loans as of December 31, 2004, of which $8.1
      million was government guaranteed. Much of the increase in nonaccrual loans
      for
      2006 is due to a $5.9 million real estate project located in the North San
      Diego
      county coast area. We do not anticipate incurring any loss on this project.
      The
      allowance for loan losses was $12.5 million at December 31, 2006, compared
      to
      $9.0 million at December 31, 2005, and $6.4 million at December 31, 2004. Net
      charge-offs were $167 thousand in 2006, $220 thousand in 2005, and $1.1 million
      in 2004.




42


*Non-Interest Income*





Non-interest
      income is an important revenue source. 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 $19.4 in 2006,
      compared to $23.8 million in 2005, and $28.9 million in 2004. The primary
      contributor to the decrease in non-interest income from 2004 to 2005 was the
      decrease in the gain on loan sales. The primary contributor to the decrease
      in
      non-interest income from 2005 to 2006 was the decrease in the SBA servicing
      income. The following table summarizes the components of non-interest income
      as
      of December 31, 2006, 2005, and 2004.





Analysis
                of Changes in Non-Interest IncomeIncrease/Decrease
            
            
            
            
            Increase/Decrease2006
            
            
            Amount
            
            %
            
            
            2005
            
            
            Amount
            
            %
            
            
            2004(dollars
                in thousands)Service
                charges and fees
            $
            618
            
            
            $
            14
            
            
            2%
            
            
            $
            604
            
            $
            (64
            )
            
            (10%
            )
            
            $
            668Gain
                on loan sales
            
            13,165
            
            
            
            (226
            )
            
            (2%
            )
            
            
            13,391
            
            
            (5,467
            )
            
            (29%
            )
            
            
            18,858Loan
                broker income
            
            4,314
            
            
            
            923
            
            
            27%
            
            
            
            3,391
            
            
            (77
            )
            
            (2%
            )
            
            
            3,468Servicing
                income
            
            (2,615
            )
            
            
            (5,253
            )
            
            (199%
            )
            
            
            2,638
            
            
            138
            
            
            6%
            
            
            
            2,500Loan
                Related Income
            
            2,216
            
            
            
            (176
            )
            
            (7%
            )
            
            
            2,392
            
            
            15
            
            
            1%
            
            
            
            2,377Other
                income
            
            1,746
            
            
            
            340
            
            
            24%
            
            
            
            1,406
            
            
            579
            
            
            70%
            
            
            
            827Total
            $
            19,444
            
            
            $
            (4,378
            )
            
            (18%
            )
            
            $
            23,822
            
            $
            (4,876
            )
            
            (17%
            )
            
            $
            28,698




The
      following table summarizes the gain on sale of loans and other assets as of
      December 31, 2006, 2005, and 2004.




Gain
                on Sale of Loans / Assets2006
            
            2005
            
            2004(dollars
                in thousands)SBA
                7A Unguaranteed Sales
            $
            3,443
            
            
            $
            6,510
            
            
            $
            6,361SBA
                7A Guaranteed Sales
            
            5,948
            
            
            
            5,113
            
            
            
            8,795SBA
                504 Sales
            
            1,278
            
            
            
            290
            
            
            
            941Mortgage
                Sales
            
            -
            
            
            
            285
            
            
            
            1,511Other
                Loan Related
            
            2,496
            
            
            
            1,192
            
            
            
            1,250REO
                Gain (Loss)
            
            75
            
            
            
            (26
            )
            
            
            (73
            )Fixed
                Assets
            
            (8
            )
            
            
            5
            
            
            
            5Total
            $
            13,232
            
            
            $
            13,369
            
            
            $
            18,790





The SBA
      servicing loss was $2.6 million in 2006. SBA servicing income was $2.6 million
      in 2005 and $2.5 million in 2004. The following table summarizes components
      of
      the SBA servicing income as of December 31, 2006, 2005, and 2004.


SBA
                Servicing Income2006
            
            2005
            
            2004(dollars
                in thousands)SBA
                Servicing Income
            $
            9,077
            
            
            $
            10,265
            
            
            $
            8,738SBA
                Servicing Guarantee Fee
            
            (205
            )
            
            
            (134
            )
            
            
            (118
            )SBA
                Servicing Excess Amortization
            
            (11,487
            )
            
            
            (7,493
            )
            
            
            (6,120
            )Total
            $
            (2,615
            )
            
            $
            2,638
            
            
            $
            2,500





Due
      to
      most SBA 7(a) loans with an SBA guarantee now being sold in the secondary market
      for a cash premium instead of at par (par loan sales carry a higher servicing
      rate) the weighted-average rate on the servicing asset has been decreasing.
      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 SBA 7(a) guaranteed
      servicing portfolio balance as of December 31, 2005 was $403.3 million with
      a
      weighted-average servicing and I/O rate of 2.46%. The decrease in the servicing
      income was a result of increasing the amortization 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.




43


***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 $47.0
      million in 2006, compared to $40.6 million in 2005, and $34.0 million in 2004.
      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, 2006, 2005, and 2004:





Analysis
                of Changes in Non-Interest ExpenseIncrease/Decrease
            
            
            
            
            
            
            Increase/Decrease2006
            
            
            Amount
            
            %
            
            
            
            2005
            
            
            Amount
            
            %
            
            
            2004(dollars
                in thousands)Salaries
                and employee benefits
            $
            31,989
            
            
            $
            5,018
            
            
            19%
            
            
            $
            26,971
            
            
            $
            4,456
            
            
            20%
            
            
            $
            22,515Occupancy
                of premises
            
            3,035
            
            
            
            607
            
            
            25%
            
            
            
            2,428
            
            
            
            703
            
            
            41%
            
            
            
            1,725Furniture
                and equipment
            
            1,719
            
            
            
            207
            
            
            14%
            
            
            
            1,512
            
            
            
            376
            
            
            33%
            
            
            
            1,136Data
                processing
            
            1,265
            
            
            
            138
            
            
            12%
            
            
            
            1,127
            
            
            
            112
            
            
            11%
            
            
            
            1,015Marketing
                and Business Promotion
            
            971
            
            
            
            (151
            )
            
            (13%
            )
            
            
            1,122
            
            
            
            154
            
            
            16%
            
            
            
            968Legal
                and Professional
            
            1,143
            
            
            
            88
            
            
            8%
            
            
            
            1,055
            
            
            
            350
            
            
            50%
            
            
            
            705Regulatory
                Assessments
            
            185
            
            
            
            (61
            )
            
            (25%
            )
            
            
            246
            
            
            
            70
            
            
            40%
            
            
            
            176Travel
                & Entertainment
            
            1,125
            
            
            
            177
            
            
            19%
            
            
            
            948
            
            
            
            244
            
            
            35%
            
            
            
            704Loan
                Related Expense
            
            2,367
            
            
            
            229
            
            
            11%
            
            
            
            2,138
            
            
            
            374
            
            
            21%
            
            
            
            1,764Office
                Expenses
            
            2,596
            
            
            
            (81
            )
            
            (3%
            )
            
            
            2,677
            
            
            
            440
            
            
            20%
            
            
            
            2,237Other
                Expenses
            
            596
            
            
            
            193
            
            
            48%
            
            
            
            403
            
            
            
            (615
            )
            
            (60%
            )
            
            
            1,018Total
            $
            46,991
            
            
            $
            6,364
            
            
            16%
            
            
            $
            40,627
            
            
            $
            6,664
            
            
            20%
            
            
            $
            33,963





Salaries
      and benefits were $32.0 million in 2006, compared to $27.0 million in 2005,
      and
      $22.5 million in 2004. 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 and Ontario branches,
      the Inland Empire loan production unit, and expansion of SBA related operations.
      Included in the salaries and benefits expense in 2006 is $1.1 million for
      stock-based compensation for all share-based payments vested in 2006 as a result
      of the adoption of SFAS No. 123R. The increase in 2005 was due to the continued
      expansion of the SBA and related sales staff, and the opening of our Carlsbad
      branch.





Occupancy
      expense was $3.0 million in 2006, compared to $2.4 million in 2005, and $1.7
      million in 2004. Furniture and equipment expense was $1.7 million in 2006,
      compared to $1.5 million in 2005, and $1.1 million in 2004. Contributing to
      these increases are the costs related to the opening of the Solana Beach and
      Ontario branches in 2006, and the Carlsbad branch in 2005.





Legal
      and
      professional expenses were $1.1 million in 2006 and 2005, and $705 thousand
      in
      2004. The increase in legal and professional expenses from 2004 to 2006 is
      largely related to t he
      increased external and internal audit fees related to Sarbanes-Oxley
      compliance .





Regulatory
      assessments were $185 thousand in 2006, compared to $246 thousand in 2005,
      and
      $176 thousand in 2004. The decrease in regulatory assessment expenses is a
      result of converting from a national charter to a state charter in June 2005
      which reduced our examination fees.





Loan
      funding expenses were $2.4 million in 2006, compared to $2.1 million in 2005,
      and $1.8 million in 2004. The increase in loan funding expense is a result
      of
      the continued growth in our loan portfolio.





***Income
      Taxes***





For
      2006,
      the tax expense was $11.7 million, for an effective rate of 40.8%, for 2005
      the
      tax expense was $9.9 million, for an effective rate of 41.5%, and for 2004,
      the
      tax expense was $7.5 million, for an effective rate of 41.6%. 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 $7.8 million at December
      31,
      2006, $5.7 million at December 31, 2005, and $4.4 million at December 31, 2004.
      Over half of the deferred tax asset is due to the tax deductibility timing
      difference of the provision for loan losses.


44


**Financial
      Condition**





***General***




As
      of
      December 31, 2006, total assets increased 42.49% to $1.24 billion, compared
      to
      $869.0 million as of December 31, 2005, and $606.8 million as of December 31,
      2004. Total gross loans increased to $1.15 billion as of December 31, 2006,
      or
      51.20%, compared to $758.1 million as of December 31, 2005, and $533.9 million
      as of December 31, 2004. Deposits grew 45.67% to $1.08 billion as of December
      31, 2006, compared to $742.4 million as of December 31, 2005, and $534.8 million
      as of December 31, 2004.




***Assets***




Total
      assets were $1.24 billion at December 31, 2006, compared to $869.0 million
      at
      December 31, 2005, a 42.49% increase. The increase was due to a $6.4 million
      increase in cash surrender value of life insurance, and an increase in gross
      loans, including loans held-for-sale, outstanding of $388.1 million. Asset
      growth is expected to continue due to the expansion of our branches, growth
      of
      the SBA unguaranteed purchase program, 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 $1.15 billion at December 31, 2006, compared to $758.1 million
      at December 31, 2005, a 51.20% increase. Much of the increase is due to
      increases in construction loans 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 16% of loans outstanding at December 31,
      2006, 13% of total loans outstanding at December 31, 2005, and 22% as of
      December 31, 2004. Due to the strong real estate market, and the inherent nature
      of community bank loan markets, approximately 94% of the loan portfolio is
      in
      real estate secured loans as of December 31, 2006, compared to 95% and 94%
      for
      comparable periods in 2005 and 2004, respectively.





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 16% of net loans outstanding at December 31, 2006 and
      13%
      of net loans outstanding as of December 31, 2005. Due to the strong real estate
      market, and the inherent nature of community bank loan markets, approximately
      94% of our loan portfolio at December 31, 2006 was in real estate secured loans,
      compared to 95% at December 31, 2005. At December 31, 2006, approximately 5%
      of
      the loans were commercial loans, compared to approximately 3% at December 31,
      2005. 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 unguaranteed purchase program, the
      wholesale SBA program, and growth of our branch system.





The
      allowance for loan losses was $12.5 million at December 31, 2006, compared
      to
      $9.0 million at December 31, 2005. Net charge-offs were $167 thousand in 2006
      and $220 thousand in 2005. The provision for loan losses was $3.7 million in
      2006 and $2.9 million in 2005. The increase in the provision is a result of
      our
      continued strong loan growth. The allowance, as a percentage of net loans
      outstanding, including loans held-for-sale, was 1.10% and 1.20% at December
      31,
      2006 and 2005, respectively. The allowance, as a percentage of net loans
      outstanding, excluding loans held-for-sale, was 1.29% and 1.35% at December
      31,
      2006 and 2005, respectively.





Federal
      Funds Sold were $18.2 million at December 31, 2006, compared to $33.2 million
      at
      December 31, 2005. The change from 2005 to 2006 is largely attributable to
      a $30
      million decrease in FHLB borrowings, net loans outstanding increasing $46.9
      million more than deposits, offset by proceeds from the private placement stock
      offering, and stock options exercised.





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. The SBA I/O strip receivable at December 31, 2006 had an
      unrealized loss of $296 thousand that decreased its value to $13.2 million.
      At
      December 31, 2005, the SBA servicing asset was $8.2 million, the SBA I/O strip
      receivable was $22.1 million, and the cash surrender value of life insurance
      was
      $17.6 million. The SBA I/O strip receivable at December 31, 2005 had an
      unrealized gain of $706 thousand that increased its value to $22.1
      million.





***Loan
      Portfolio***




Healthy
      loan demand in 2006 resulted in a 134.4% increase in commercial loans, a 39.3%
      increase in construction lending, an 18.7% increase in real estate lending,
      and
      a 134.3% increase in SBA loans. At December 31, 2006 and 2005, there were no
      residential mortgage loans outstanding. Residential mortgage loans outstanding
      were $2.2 million as of December 31, 2004. We originated brokered loans,
      totaling $96.7 million in 2006, compared with $75.0 million in 2005, and $105.5
      million in 2004. Sales of mortgage loans totaled $13.7 million in 2005 and
      $45.2
      million in 2004. There were no sales of mortgage loans in 2006. The servicing
      portfolio, which consists of SBA loans sold to other investors, was $480.0
      million as of December 31, 2006, compared to $503.2 million as of
      December 31, 2005, and $440.3 million as of December 31,
      2004.




45


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 $20.5 million of
      nonperforming assets as of December 31 2006, of which $11.0 million was
      guaranteed by the SBA, compared to $10.1 million of nonperforming assets as
      of
      December 31, 2005, of which $7.1 million was government guaranteed, and $12.1
      million of nonperforming assets as of December 31, 2004, of which $8.4 million
      was government guaranteed. Much of the increase in nonaccrual loans for 2006
      is
      due to a $5.9 million real estate project located in the North San Diego county
      coast area. We do not anticipate incurring any loss on this project. 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, and $303 thousand of OREO at December 31,
      2004, of which $227 thousand was guaranteed by the SBA.





***Nonaccrual
      Loans***





Nonaccrual
      loans, net of the government guaranteed portion, were $8.8 million or 0.77
      % of
      total gross loans as of December 31, 2006, compared to $1.4 million or 0.19
      % of
      total gross loans as of December 31, 2005, and $3.7 million or 0.69% of total
      gross loans as of December 31, 2004.





***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 monthly.
      Classified assets, net of government guarantees, (loans graded as substandard
      or
      lower and OREO) at December 31, 2006, 2005, and 2004 were $19.5 million, $5.0
      million, and $6.9 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, 2006
      were $167 thousand or 0.02% of average gross loans outstanding, compared to
      $220
      thousand or 0.03% of average gross loans outstanding, for the year ended
      December 31, 2005, and $1.1 million or 0.24% of average gross loans outstanding,
      for the year ended December 31, 2004.





***Allowance
      for Loan Losses***





As
      of
      December 31, 2006, the balance in the allowance for loan losses was $12.5
      million, compared to $9.0 million as of December 31, 2005, and $6.4 million
      as
      of December 31, 2004. 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 reserve 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 1.10% of total net loans and loans
      held-for-sale as of December 31, 2006, and 1.20% as of December 31, 2005 and
      2004, respectively. The allowance for loan losses was 1.29% of total net loans
      excluding loans held-for-sale as of December 31, 2006, 1.35% as of December
      31,
      2005, and 1.29% as of December 31, 2005. The allowance for loan losses as a
      percentage of gross nonaccrual loans was 65.48% as of December 31, 2006,
      compared to 113.69% as of December 31, 2005, and 53.92% as of December 31,
      2004.
      The allowance for loan losses to nonperforming loans, net of government
      guarantees was 142.46% as of December 31, 2006, compared to 629.10% as of
      December 31, 2005, and 173.88% as of December 31, 2004.


46


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, 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. During the year ended December 31, 2004, we charged off $1.1 million
      (net of recoveries) and provided $3.8 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
      2004, 2005, and 2006, net charge offs as a percentage of average loans
      outstanding were only 0.24%, 0.03%, and 0.02%, respectively. We have established
      loss reserve allocations for each homogeneous category based upon loan type,
      as
      well as specific reserves 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”). Currently there are 15 current and previously employed executives
      covered by BOLI. The BOLI had a balance of $24.0 million at December 31, 2006,
      compared to $17.6 million at December 31, 2005, and $9.6 million at December
      31,
      2004. The total death benefit at December 31, 2006 was approximately $49.1
      million. The BOLI earnings in 2006, net of mortality cost, were $755 thousand,
      compared to $507 thousand in 2005, and $281 thousand in 2004. The net earnings
      of BOLI are tax-free. The SCP expense before tax in 2006 was $654 thousand,
      compared to $723 thousand in 2005, and $1.1 million in 2004. 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 amortized in proportion to and over the period of estimated future
      net servicing income. 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. Our management evaluates the servicing
      asset for impairment quarterly. For purposes of measuring impairment, the future
      servicing cashflows are stratified based on original term to maturity, the
      expected life of the loans, and year of origination. The amount of impairment
      recognized is the amount by which the servicing asset for a stratum exceeds
      their fair value.





47


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 asset represents the value of the contractual servicing fee less
      adequate compensation. Adequate compensation 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, 2006, 2005, and 2004, we had I/O strips of $13.2 million, $22.1
      million, and $24.7 million respectively, which approximate fair value. The
      interest-only strips are 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. 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 appraisal of fair value on a quarterly basis.





The
      net
      servicing asset increased to $8.3 million as of December 31, 2006, compared
      to
      $8.2 million as of December 31, 2005, and $7.6 million as of December 31, 2004.
      The increase reflects the additions due to loan sales during the year ended
      December 31, 2006 offset by amortization of the servicing asset. 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 $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 and $2.4 million at December 31, 2004. We had $18.2
      million in Fed Funds Sold at December 31, 2006, compared to $33.2 million at
      December 31, 2005, and $16.8 million at December 31, 2004.





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
      2006,
      the ratio of interest-earning assets to total assets was 91.49%, for 2005 it
      was
      87.96% and for 2004 it was 86.09%. Our goal is to maintain at least 90% of
      our
      assets as interest-earning. For 2005 and 2004 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.




48


***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 $5.5 million, $4.9 million, and $4.4 million as
                of
                December 31, 2006, 2005, and 2004, respectively. The increase has
                mainly
                been due to upgrades to information technology systems and expansion
                of
                the number of branches and loan production
                offices.


·
            Accrued
                interest was $6.2 million, $3.5 million, and $1.9 million as of December
                31, 2006, 2005, and 2004, respectively. The increase in accrued interest
                is due to the increase in yield on loans from 7.48% for the year
                ended
                December 31, 2004 to 9.12% for the year ended December 31, 2005,
                and
                10.12% for the year ended December 31, 2006, as well as the
                significant increase in loan balances. Average loan balances increased
                to
                $922.3 million for 2006, compared to $634.7 million for 2005, and
                $446.5
                million for 2004.


·
            Deferred
                tax assets were $7.8 million, $5.7 million, and $4.4 million as of
                December 31, 2006, 2005, and 2004, respectively. Over half of the
                deferred
                tax asset is due to the tax deductibility timing difference of the
                provision for loan loss.





***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 $1.08 billion at December
      31,
      2006, compared to $742.4 million at December 31, 2005, a $339.1 million or
      45.67% increase. Demand deposits decreased 11.5 million, money market and NOW
      accounts increased $36.5 million, savings decreased $5.1, and certificate of
      deposits (CD's) increased $319.1 million, of which $47.2 million were brokered
      deposits. Non interest-bearing demand deposits comprised approximately 13%
      of
      deposits at December 31, 2006, compared to 21% at December 31, 2005. The loan
      to
      deposit ratio increased to 105.66% at December 31, 2006 from 101.46% at December
      31, 2005.





At
      December 31, 2006, approximately 59% of deposits had balances of $100,000 or
      more. At December 31, 2006, none of our customers (excluding brokered deposits)
      had balances that exceeded 2% of our bank’s deposits. Brokered CD deposits were
      $47.2 million at December 31, 2006. There were no brokered deposits at year
      end
      2005. 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 two branches in 2006, one branch in 2005, two branches
      in 2004, and the continued deposit increases at our five 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,
      and 2006 to fund the rapid loan growth, as well as the creation of a Money
      Desk
      Department in 2005. Certificates of deposits balances in the Money Desk
      Department are deposits from other financial institutions. As of December 31,
      2006 these deposits totaled $153.6 million. The following table is a summary
      of
      our deposits by type and their percentage of distribution:


December
                31, 2006
            
            December
                31, 2005Amount
            
            Percent
            
            Amount
            
            PercentDeposit
                composition:
            (dollars
                in thousands)Non
                Interest-Bearing Demand
            $
            144,525
            
            13%
            
            $
            155,992
            
            21%Money
                Market and NOW
            
            130,357
            
            12%
            
            
            93,825
            
            13%Savings
            
            29,781
            
            3%
            
            
            34,851
            
            5%Time
                Deposits, Under $100,000
            
            367,029
            
            34%
            
            
            217,749
            
            29%Time
                Deposits, $100,000 and Over
            
            409,809
            
            38%
            
            
            240,015
            
            32%Total
                Deposits
            $
            1,081,501
            
            100%
            
            $
            742,432
            
            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 will be effective on January
      1, 2007 and will vary between five and seven cents per $100 of domestic deposits.
      We anticipate an increase in the amount we will pay for deposit insurance of
      approximately $295 thousand during 2007.





49


***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.





We
      are
      required to pledge a certain amount of loans with the FHLB for collateralization
      purposes. 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, 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. We had no FHLB
      advances as of December 31, 2004.





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, 2006:





Series
            Amount
                (000’s)
            Date Issued
            Rate
                Adjustor
            Effective
                Rate
            Maturity
                DateTemecula
                Valley Statutory Trust I
            $
            7,217
            June
                1, 2002
            3-month
                LIBOR +3.45%
            8.82%
            2032Temecula
                Valley Statutory Trust II
            
            5,155
            September
                17, 2003
            3-month
                LIBOR +2.95%
            8.31%
            2033Temecula
                Valley Statutory Trust III
            
            8,248
            September
                20, 2004
            3-month
                LIBOR +2.20%
            7.57%
            2034Temecula
                Valley Statutory Trust IV
            
            8,248
            September
                29, 2005
            3-month
                LIBOR +1.40%
            6.76%
            2035Temecula
                Valley Statutory Trust V
            
            12,372
            September
                27, 2006
            3-month
                LIBOR +1.60%
            6.96%
            2036Total
            $
            41,240





At
      our
      company, the trust preferred borrowing 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, 2006, 2005, and 2004 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.




On
      November 21, 2006, we completed a private placement stock offering of 1,400,569
      shares of common stock, no par value, to institutional and individual investors
      including employees, officers, and directors of our company or our bank, and
      our
      company's employee stock ownership plan (“ESOP”). The purchase price was $21.31
      per share for the 64,139 shares sold to 19 employees, officers, and directors
      of
      our company or our bank, and our ESOP. The purchase price for the remaining
      1,336,430 shares sold to other investors was $19.00 per share.





Pursuant
      to NASDAQ Rule 4350(i)(1)(A), the issuance of common stock by us to our
      officers, directors, employees, or consultants in a private placement at a
      price
      less than the market value of the stock is considered a form of "equity
      compensation" and would have required shareholder approval. For purposes of
      NASDAQ Rule 4350(i)(1)(A), market value is the closing bid price immediately
      preceding the time we entered into a binding agreement to issue the securities.
      In order to complete the private placement within the desired timeframe, we
      chose to proceed without seeking to obtain prior shareholder approval and
      instead sold the shares to employees, officers, and directors at market value
      or
      $21.31 per share.


50


We
      paid
      approximately $0.95 per share commission to our placement agents on shares
      sold
      in this private placement, although we paid a reduced commission of
      approximately $0.53 per share on 64,139 shares sold to our employees, officers,
      directors, and our ESOP. The sale resulted in net proceeds of approximately
      $25.1 million.





The
      proceeds we received in the private placement will be used to fund our growth
      to
      the extent growth in retained earnings is insufficient to satisfy regulatory
      requirements for additional capital, if necessary, in connection with loan
      concentrations, and to possibly pay down up to $7.0 million in higher cost
      trust
      preferred securities.





The
      placement was made under the exemption from registration provided by Section
      4(2) of the Securities Act of 1933, as amended, and Rule 506 of Regulation
      D
      thereunder, to accredited and sophisticated purchasers.





A
      registration statement covering the resale of the shares of common stock issued
      in the placement under Registration No. 333-139908 became effective February
      21,
      2007.





Total
      capital was $103.3 million at December 31, 2006 and $58.2 million at December
      31, 2005. 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. For 2005, the $15.3 million, or increase of 35.61%,
      consisted of $14.0 million of net income, $409 thousand of other comprehensive
      income, and $916 thousand on the exercise of stock options. Our average equity
      to average assets ratio was 6.88%, 6.96%, and 6.93% at December 31, 2006, 2005,
      and 2004, respectively.




Since
      1998, there have been three two-for-one stock splits to shareholders, the last
      one declared in December 2003. 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 12.40% and tier one leverage capital was 11.42% at
      December 31, 2006, compared to 11.02% and 9.28% at December 31, 2005. At
      December 31, 2006 and 2005 our bank was within the regulatory “well capitalized”
category.




At
      the
      end of 2006 and 2005, 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.




The
      following tables present the regulatory standards for well capitalized
      institutions and the capital ratios for our company and our bank at
      December 31, 2006, 2005, and 2004.




Minimum
                Required for Capital Adequacy Purposes
            
            Actual
                Ratio
              December
                31**Temecula
                Valley Bancorp**
            
            
            
            
            2006
            2005
            2004Tier
                1 leverage
            
            4.0%
            
            
            11.4%
            9.3%
            9.2%Tier
                1 risk-based capital
            
            4.0%
            
            
            10.9%
            8.9%
            9.7%Total
                risk-based capital
            
            8.0%
            
            
            12.4%
            11.0%
            11.8%





Minimum
                Required for Capital Adequacy Purposes
            
            To
                Be Well Capitalized Under Prompt Corrective Action
                Provisions
            
            Actual
                Ratio
              December
                31**Temecula
                Valley Bank**
            
            
            
            
            
            
            
            
            2006
            2005
            2004Tier
                1 leverage
            
            4.0%
            
            
            5.0%
            
            
            
            11.2%
            10.2%
            10.0%Tier
                1 risk-based capital
            
            4.0%
            
            
            6.0%
            
            
            
            10.7%
            9.8%
            10.5%Total
                risk-based capital
            
            8.0%
            
            
            10.0%
            
            
            
            11.7%
            10.8%
            11.6%




51


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, 2006 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,
      2006, the liquidity gap position was 14.57%. Another analysis measures an
      industry standard liquidity ratio. Our guidelines state a 10% ratio or more
      should be maintained. At December 31, 2006 the ratio was 18.94%.





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 $38.0 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, 2006, our borrowing
      capacity with the FHLB was $73.8 million and at December 31, 2005 was $30.1
      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, 2006, 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 $62.5 million during the
      2006, $25.6 million during 2005, and $5.2 million during 2004.





Net
      cash
      used by investing activities of $304.7 million during 2006, $192.8 million
      during 2005, and $163.7 million during 2004. The outflow in 2006 is attributed
      to the growth in our loan portfolio in excess of proceeds from principal
      repayments on loans held for investment, as well as the purchase of the
      unguaranteed portion of 7(a) loans.


We
      experienced net cash provided by financing activities of $349.1 million during
      2006, $246.8 million during 2005, and $161.2 million during 2004. The inflow
      in
      2006 is attributable to the increases in time deposits, the issuance of a junior
      subordinated debt security, and proceeds from a private placement stock
      offering.





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. For the year ended December 31,
      2006, 2005, and 2004, no dividends were paid by our bank to our company.





***Contractual
      Obligations and Commitments***





At
      December 31, 2006, we had commitments to extend credit of $398.4 million and
      obligations under letters of credit of $3.5 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.





52


The
      following tables set forth the maturities of our outstanding financial
      commitments as of December 31, 2006 and 2005.




Maturities
                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
            
            
            40,152FHLB
                Advances
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Junior
                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
            
            $
            81,773Maturities
                for Loan Commitments and Related Financial Instruments as of December
                31,
                2005Maturity
                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
            $
            381,603
            
            $
            249,368
            
            $
            83,953
            
            $
            627
            
            $
            47,655Letters
                of Credit
            
            4,775
            
            
            4,630
            
            
            3
            
            
            -
            
            
            142Loan
                Commitments Outstanding
            
            386,378
            
            
            253,998
            
            
            83,956
            
            
            627
            
            
            47,797FHLB
                Advances
            
            30,000
            
            
            30,000
            
            
            -
            
            
            -
            
            
            -Junior
                Subordinated Debt
            
            28,868
            
            
            -
            
            
            -
            
            
            -
            
            
            28,868Operating
                Lease Obligations
            
            5,527
            
            
            1,587
            
            
            2,500
            
            
            908
            
            
            532Other
                Commitments Outstanding
            
            64,395
            
            
            31,587
            
            
            2,500
            
            
            908
            
            
            29,400Total
                Outstanding Commitments
            $
            450,773
            
            $
            285,585
            
            $
            86,456
            
            $
            1,535
            
            $
            77,197


***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, for stock option 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.




53




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. For a further
      discussion of this risk, see “Management’s Discussion and Analysis of Financial
      Condition and Results of Operations - Financial Condition - Risk Management”
included in this report. 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, 2006, approximately 72% 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, 2006, 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.




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 2007 based
      on
      asset and liability levels using the December 31, 2006 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, 2006, our internal prime rate was 10.25% and Wall Street Journal
      prime rate was 8.25%.





54


Changes
                in
            Projected
                Net
            
            
            Change
                from
            %
                Change fromRates
            Interest
                Income
            
            
            Base
                Case
            base
                Case(dollars
                in thousands)+300
            bp
            $
            49,539
            
            $
            (13,971
            )
            (22.00%
            )+200
            bp
            
            53,980
            
            
            (9,530
            )
            (15.01%
            )+100
            bp
            
            58,645
            
            
            (4,865
            )
            (7.66%
            )0
            bp
            
            63,510
            
            
            -
            
            0.00%-100
            bp
            
            68,946
            
            
            5,436
            
            8.56%-200
            bp
            
            74,368
            
            
            10,858
            
            17.10%-300
            bp
            
            79,773
            
            
            16,263
            
            25.61%





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 two independent registered public
      accountants are included in this report immediately following Part
      IV.




**ITEM
        9:****CHANGES
        IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
        DISCLOSURE**


In
        April
        2005, Vavrinek, Trine, Day & Co., LLP (“Vavrinek”) resigned as our company’s
        independent auditors. The resignation was prompted by the fact that, by mutual
        agreement between us and Vavrinek, it would be prudent to engage a firm with
        more resources to match our anticipated growth and operating complexity as
        well
        as a firm with several accelerated filer clients with stock that is publicly
        traded. This decision was approved by our Audit Committee and our Board.
        During
        the time we engaged Vavrinek, including our fiscal year ended December 31,
        2004,
        Vavrinek has never issued to us an adverse opinion or a disclaimer of opinion,
        and none of Vavrinek’s opinions during such periods were qualified or modified
        as to uncertainty, audit scope or accounting principals. Moreover, during
        the
        time we engaged Vavrinek, including our fiscal years ended December 31, 2003
        and
        2004, there has never been, at any time, any disagreements on any matter
        of
        accounting principals or practices, financial statement disclosure, or auditing
        scope or procedure with disagreement(s), if not resolved to the satisfaction
        of
        Vavrinek, would have caused it to make reference to the subject matter of
        the
        disagreement(s) in connection with its report.





The
      decision to change accountants was recommended by the Audit Committee and
      approved by our Board of Directors. On August 31, 2005, Crowe Chizek and Company
      LLP was engaged as the independent auditors for our company upon the approval
      of
      our Audit Committee.


**ITEM
        9A:****CONTROLS
        AND PROCEDURES**


As
      of
      December 31, 2006, 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, 2006. There have been no significant changes in
      our
      internal controls that occurred during the quarter ended December 31, 2006
      that has materially affected, or is reasonably likely to materially affect,
      our
      internal control over financial reporting.




55


***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.





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, 2006 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, 2006.




Our
      company’s independent registered public accounting firm has audited our
      management’s assessment of our company’s internal control over financial
      reporting as of December 31, 2006. The report by Crowe Chizek and Company,
      LLP on management’s assessment of our company’s internal control over
      financial reporting appears on page 60 of this Form 10-K.




**ITEM
      9B:**  **OTHER
      INFORMATION**





None


**PART
      III**





**ITEM
      10:****DIRECTORS,
      EXECUTIVE OFFICERS AND****CORPORATE
      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 2007 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 MANGEMENT AND RELATED STOCKHOLDER
      MATTERS**




The
      inform ation
      required by this Item is incorporated by reference our Proxy Statement for
      the
      2007 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 2007 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.




**ITEM
      14: PRINCIPAL
      ACCOUNTING FEES AND SERVICES**




The
      information required by this Item is incorporated by reference from our Proxy
      Statement for the 2007 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 ne
      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.





56


**PART
      IV**


**ITEM
      15: EXHIBITS,
      FINANCIAL STATEMENT SCHEDULES**


(a)(1),
        (a)(2) and (c)  Financial
        Statements and Financial Statement Schedules
 
 Reference
        is made to the financial statements listed on and attached in Item 8 contained
        at page 55 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)
        and (b)   Exhibits
 
 Reference
        is made to the exhibits listed on the Index to Exhibits that follows the
        financial statements.


57


**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
              13, 2007
            By:
            /s/ Stephen
              H. WacknitzStephen
                H. Wacknitz, President/CEO,
              Chairman
                of the Board By:
            /s/ Donald
              A.
              PitcherDonald
                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. Aichle
            Director
            March
                13, 2007Dr. Steven W. Aichle/s/
              Dr. Robert P. Beck
            Director
            March
                  13, 2007Dr. Robert P. Beck/s/
              Neil M. Cleveland
            Director
            March
                  13, 2007Neil M. Cleveland/s/
              George Cossolias
            Director
            March
                  13, 2007George Cossolias/s/
              Luther J. Mohr
            Director
            March
                  13, 2007Luther J. Mohr/s/
              Stephen H. Wacknitz
            Chairman
            March
                13, 2007Stephen H. Wacknitz/s/
              Richard W. Wright
            Director
            March
                13, 2007Richard W. Wright










58


**EXHIBIT
                  LIST**Exhibit10.20
              Amended
                and Restated Salary Continuation Agreement between Temecula Valley
                Bank
                and Scott J. Word entered into December 29, 2006.10.24
              Amended
                and Restated Split Dollar Agreement between Temecula Valley Bank
                and Scott
                J. Word entered into December 29, 2006.10.27
              Amended
                  and Restated Salary Continuation Agreement between Temecula Valley
                  Bank
                  and Thomas M. Shepherd entered into December 29,
                  2006.10.28
              Amended
                  and Restated Split Dollar Agreement between Temecula Valley Bank
                  and
                  Thomas M. Shepherd entered into December 29, 2006.10.29
              Amended
                  and Restated Salary Continuation Agreement between Temecula Valley
                  Bank
                  and Donald A. Pitcher entered into December 29, 2006.10.30
              Amended
                  and Restated Split Dollar Agreement between Temecula Valley Bank
                  and
                  Donald A. Pitcher entered into December 29, 2006.10.45
              Executive
                  Supplemental Compensation Agreement between Temecula Valley Bank
                  and James
                  W. Andrews entered into December 29, 2006.10.46
              Split
                  Dollar Agreement between Temecula Valley Bank and James W. Andrews
                  entered
                  into December 29, 2006.10.47
              First
                  Amendment dated December 29, 2006 to the Split Dollar Agreement
                  between
                  Temecula Valley Bank and William H. McGaughey dated June 1,
                  2006.10.48
              Executive
                  Supplemental Compensation Agreement between Temecula Valley Bank
                  and
                  Martin E. Plourd entered into December 29, 2006.10.49
              Split
                  Dollar Agreement between Temecula Valley Bank and Martin E. Plourd
                  entered
                  into December 29, 2006.10.50
              Executive
                  Supplemental Compensation Agreement between Temecula Valley Bank
                  and Frank
                  Basirico, Jr. entered into December 29, 2006.10.51
              Split
                  Dollar Agreement between Temecula Valley Bank and Frank Basirico,
                  Jr.entered into December 29, 2006.23.1
              Consent
                  of Independent Registered Public Accountants.23.2
              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.





59


**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,
      2006 and 2005, and the related consolidated statements of income, changes in
      shareholders' equity, and cash flows for the years then ended. We have also
      audited management’s assessment, included in the accompanying Management’s
      Report on Internal Control Over Financial Reporting, included in Item 9a of
      Form
      10-K, that the Company maintained effective internal control over financial
      reporting as of December 31, 2006, 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.
      Our responsibility is to express an opinion on these financial statements,
      an
      opinion on management’s assessment, 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 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, evaluating management’s assessment, testing
      and evaluating the design and operating effectiveness of internal control,
      and
      performing such other procedures as we considered necessary in the
      circumstances. We believe that our 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, 2006 and 2005, and the results of their
      operations and their cash flows for the years then ended in conformity with
      accounting principles generally accepted in the United States of America. Also
      in our opinion, management’s assessment that the Company maintained effective
      internal control over financial reporting as of December 31, 2006, is fairly
      stated, in all material respects, based on criteria established in *Internal
      Control-Integrated Framework issued by the Committee of Sponsoring Organizations
      of the Treadway Commission* (COSO).
      Furthermore, in our opinion, the Company maintained, in all material respects,
      effective internal control over financial reporting as of December 31, 2006,
      based on criteria established in *Internal
      Control-Integrated Framework issued by the Committee of Sponsoring Organizations
      of the Treadway Commission* (COSO).





As
      discussed in Note A to the Consolidated Financial Statements, the Company
      adopted new accounting guidance which impacts the accounting for stock
      options.





Crowe
      Chizek and Company LLP


Oak
      Brook, Illinois


March
      13, 2007


60


**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**





Board
      of
      Directors and Shareholders of


Temecula
      Valley Bancorp Inc. and Subsidiary





We
      have
      audited the accompanying consolidated statement of financial condition of
      Temecula Valley Bancorp Inc. and Subsidiary as of December 31, 2004 and the
      related consolidated statements of income, changes in shareholders' equity,
      and
      cash flows for the year then ended December 31, 2004. These consolidated
      financial statements are the responsibility of the Company’s management. Our
      responsibility is to express an opinion on these consolidated financial
      statements based on our audits.





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





In
      our
      opinion, the consolidated financial statements referred to above present fairly,
      in all material respects, the financial position of Temecula Valley Bancorp
      Inc.
      and Subsidiary as of December 31, 2004, and the results of its operations and
      its cash flows for the year then ended December 31, 2004, in conformity with
      accounting principles generally accepted in the United States of
      America.





Vavrinek,
      Trine, Day & Co., LLP





Laguna
      Hills, California


March
      23,
      2005


61





**TEMECULA
                VALLEY BANCORP INC. AND SUBSIDIARY****CONSOLIDATED
                STATEMENTS OF FINANCIAL CONDITION**(in
                thousands, except share and per share data)December
                31,**ASSETS**
            2006
            
            2005Cash
                and Due from Banks
            $
            15,190
            
            
            $
            18,312Interest-bearing
                deposits in financial institutions
            
            99
            
            
            
            -Federal
                Funds Sold
            
            18,180
            
            
            
            33,200**TOTAL
                CASH AND CASH EQUIVALENTS**
            
            33,469
            
            
            
            51,512FNMA
                Mortgage-backed securities HTM (fair value of $1,029)
            
            1,019
            
            
            
            -Loans
                Held-for-Sale
            
            173,120
            
            
            
            82,813Loans:Commercial
            
            59,663
            
            
            
            25,457Real
                Estate - Construction
            
            462,562
            
            
            
            332,184Real
                Estate - Other
            
            294,220
            
            
            
            248,026SBA
            
            152,980
            
            
            
            65,294Consumer
                and other
            
            3,684
            
            
            
            4,320**TOTAL
                LOANS HELD IN PORTFOLIO**
            
            973,109
            
            
            
            675,281Net
                Deferred Loan Fees
            
            (3,536
            )
            
            
            (4,848
            )Allowance
                for Loan Losses
            
            (12,522
            )
            
            
            (9,039
            )**TOTAL
                NET LOANS HELD IN PORTFOLIO**
            
            957,051
            
            
            
            661,394Federal
                Reserve and Federal Home Loan Bank Stock, at Cost
            
            1,996
            
            
            
            3,099Premises
                and Equipment
            
            5,492
            
            
            
            4,885Other
                Real Estate Owned
            
            1,255
            
            
            
            2,111Cash
                Surrender Value of Life Insurance
            
            24,036
            
            
            
            17,591Deferred
                Tax Assets
            
            8,480
            
            
            
            5,744SBA
                Servicing Assets
            
            8,288
            
            
            
            8,169SBA
                Interest-Only Strips Receivable
            
            13,215
            
            
            
            22,068Accrued
                Interest Receivable
            
            6,155
            
            
            
            3,471Other
                Assets
            
            4,613
            
            
            
            6,131**TOTAL
                ASSETS**
            $
            1,238,189
            
            
            $
            868,988**LIABILITIES
                AND SHAREHOLDERS' EQUITY**Deposits:Non
                Interest-Bearing Demand
            $
            144,525
            
            
            $
            155,992Money
                Market and NOW
            
            130,357
            
            
            
            93,825Savings
            
            29,781
            
            
            
            34,851Time
                Deposits, Under $100,000
            
            367,029
            
            
            
            217,749Time
                Deposits, $100,000 and Over
            
            409,809
            
            
            
            240,015**TOTAL
                DEPOSITS**
            
            1,081,501
            
            
            
            742,432FHLB
                Advances
            
            -
            
            
            
            30,000Accrued
                Interest Payable
            
            2,094
            
            
            
            957Junior
                Subordinated Debt
            
            41,240
            
            
            
            28,868Other
                Liabilities
            
            10,091
            
            
            
            8,550**TOTAL
                LIABILITIES**
            
            1,134,926
            
            
            
            810,807Shareholders'
                Equity:Common
                Stock No Par Value; 40,000,000 SharesAuthorized;
                10,586,659 and 8,897,697 Shares Issuedand
                Outstanding at December 31, 2006 and December 31, 2005
            46,383
            
            
            
            17,640Accumulated
                other comprehensive income (loss)
            
            (172
            )
            
            
            409Retained
                Earnings
            
            57,052
            
            
            
            40,132**TOTAL
                SHAREHOLDERS' EQUITY**
            
            103,263
            
            
            
            58,181**TOTAL
                LIABILITIES AND SHAREHOLDERS' EQUITY**
            $
            1,238,189
            
            
            $
            868,988


See
      accompanying notes to the consolidated financial statements





62


**TEMECULA
                VALLEY BANCORP, INC AND SUBSIDIARY****CONSOLIDATED
                STATEMENTS OF INCOME****FOR
                THE YEARS ENDED DECEMBER 31, 2006, 2005, and
                2004**(in
                thousands, except share and per share data)**INTEREST
                INCOME**
            2006
            
            2005
            
            2004Loans,
                including fees
            $
            93,378
            
            
            $
            57,880
            
            
            $
            33,502Interest-bearing
                deposits in financial institutions
            
            3
            
            
            
            -
            
            
            
            -Federal
                Funds Sold
            
            829
            
            
            
            239
            
            
            
            111Securities
            
            19
            
            
            
            6
            
            
            
            2**TOTAL
                INTEREST INCOME**
            
            94,229
            
            
            
            58,125
            
            
            
            33,615**INTEREST
                EXPENSE**Money
                Market and NOW
            
            2,773
            
            
            
            961
            
            
            
            501Savings
                Deposits
            
            122
            
            
            
            141
            
            
            
            186Time
                Deposits
            
            28,819
            
            
            
            11,848
            
            
            
            4,909Junior
                Subordinated Debt Securities and Other Borrowings
            
            2,735
            
            
            
            1,634
            
            
            
            819**TOTAL
                INTEREST EXPENSE**
            
            34,449
            
            
            
            14,584
            
            
            
            6,415**NET
                INTEREST INCOME**
            
            59,780
            
            
            
            43,541
            
            
            
            27,200Provision
                for Loan Losses
            
            3,650
            
            
            
            2,897
            
            
            
            3,821**NET
                INTEREST INCOME AFTER****PROVISION
                FOR LOAN LOSSES**
            
            56,130
            
            
            
            40,644
            
            
            
            23,379**NON
                INTEREST INCOME**Service
                Charges and Fees
            
            618
            
            
            
            604
            
            
            
            668Gain
                on Sale of Loans
            
            13,165
            
            
            
            13,391
            
            
            
            18,858Gain
                (Loss) on Other Assets and Other Real Estate Owned
            
            67
            
            
            
            (22
            )
            
            
            (68
            )Servicing
                Income (loss)
            
            (2,615
            )
            
            
            2,638
            
            
            
            2,500Loan
                Broker Income
            
            4,314
            
            
            
            3,391
            
            
            
            3,468Loan
                Related Income
            
            2,216
            
            
            
            2,392
            
            
            
            2,377Other
                Income
            
            1,679
            
            
            
            1,428
            
            
            
            895**TOTAL
                NON INTEREST INCOME**
            
            19,444
            
            
            
            23,822
            
            
            
            28,698**NON
                INTEREST EXPENSE**Salaries
                and Employee Benefits
            
            31,989
            
            
            
            26,971
            
            
            
            22,515Occupancy
                Expenses
            
            3,035
            
            
            
            2,428
            
            
            
            1,725Furniture
                and Equipment
            
            1,719
            
            
            
            1,512
            
            
            
            1,136Data
                Processing
            
            1,265
            
            
            
            1,127
            
            
            
            1,015Marketing
                and Business Promotion
            
            971
            
            
            
            1,122
            
            
            
            968Legal
                and Professional
            
            1,143
            
            
            
            1,055
            
            
            
            705Regulatory
                Assessments
            
            185
            
            
            
            246
            
            
            
            176Travel
                & Entertainment
            
            1,125
            
            
            
            948
            
            
            
            704Loan
                Related Expense
            
            2,367
            
            
            
            2,138
            
            
            
            1,764Office
                Expenses
            
            2,596
            
            
            
            2,677
            
            
            
            2,237Other
                Expenses
            
            596
            
            
            
            403
            
            
            
            1,018**TOTAL
                NON INTEREST EXPENSE**
            
            46,991
            
            
            
            40,627
            
            
            
            33,963**INCOME
                BEFORE INCOME TAX EXPENSE**
            
            28,583
            
            
            
            23,839
            
            
            
            18,114Income
                Tax expense
            
            11,663
            
            
            
            9,886
            
            
            
            7,536**NET
                INCOME**
            $
            16,920
            
            
            $
            13,953
            
            
            $
            10,578Per
                Share Data :Net
                Income - Basic
            
            $1.83
            
            
            
            $1.58
            
            
            
            $1.24Net
                Income - Diluted
            
            $1.73
            
            
            
            $1.46
            
            
            
            $1.13





See
      accompanying notes to the consolidated financial statements




63




**TEMECULA
                VALLEY BANCORP, INC AND SUBSIDIARY****CONSOLIDATED
                STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY****FOR
                THE YEARS ENDED DECEMBER 31, 2006, 2005, and
                2004**AccumulatedCommon
            
            
            
            
            
            OtherComprehensive
            
            
            
            
            Stock
            
            
            Retained
            
            
            ComprehensiveIncome
            
            Shares
            
            
            &
                Surplus
            
            
            Earnings
            
            
            Income
            
            
            Total(in
                thousands, except share and per share data)**Balance
                at January 1, 2004**
            
            
            
            
            8,152
            
            $
            14,082
            
            $
            15,601
            
            $
            -
            
            
            $
            29,683Exercise
                of Stock Options,Including
                the Realization of
              Tax
                Benefits of $968
            
            
            
            
            601
            
            
            2,642
            
            
            
            
            
            
            
            
            
            2,642Net
                Income
            
            
            
            
            
            
            
            
            
            
            10,578
            
            
            
            
            
            
            10,578**Balance
                at December 31, 2004**
            
            
            
            
            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
            $
            14,362**Balance
                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
                of offering costs
            
            
            
            1,401
            
            
            25,137
            
            
            
            
            
            
            
            
            
            25,137Stock-based
                compensation
            
            
            
            
            
            
            
            1,113
            
            
            
            
            
            
            
            
            
            1,113Net
                Income
            
            16,920
            
            
            
            
            
            
            
            
            16,920
            
            
            
            
            
            
            16,920Other
                comprehensive income (loss), net
            
            (581
            )
            
            
            
            
            
            
            
            
            
            
            (581
            )
            
            
            (581
            )Total
                comprehensive income
            $
            16,339**Balance
                at December 31, 2006**
            
            
            
            
            10,587
            
            $
            46,383
            
            $
            57,052
            
            $
            (172
            )
            
            $
            103,263





See
      accompanying notes to the consolidated financial statements


64





**TEMECULA
                VALLEY BANCORP INC. AND SUBSIDIARY****CONSOLIDATED
                STATEMENTS OF CASH FLOWS****FOR
                THE YEARS ENDED DECEMBER 31, 2006, 2005, and
                2004**2006
            
            
            2005
            
            
            2004**OPERATING
                ACTIVITIES**
            (dollars
                in thousands)Net
                Income
            $
            16,920
            
            
            $
            13,953
            
            
            $
            10,578Adjustments
                to Reconcile Net Income to Net Cash Provided by Operating
                Activities:
            
            
            
            
            
            
            
            `Provision
                for Loan Losses
            
            3,650
            
            
            
            2,897
            
            
            
            3,821Depreciation
                and Amortization
            
            13,139
            
            
            
            8,639
            
            
            
            6,971Amortization
                of debt issuance cost
            
            70
            
            
            
            70
            
            
            
            75Net
                amortization(accretion) of securities
            
            10
            
            
            
            -
            
            
            
            -Net
                Change in deferred loan origination fees
            
            (1,312
            )
            
            
            (1,145
            )
            
            
            (1,406
            )Provision
                for Deferred Taxes
            
            (2,314
            )
            
            
            (1,670
            )
            
            
            (1,978
            )Gain
                on Sale of Loans
            
            (13,165
            )
            
            
            (13,391
            )
            
            
            (18,858
            )Loans
                Originated for Sale
            
            (250,846
            )
            
            
            (209,936
            )
            
            
            (265,250
            )Proceeds
                from Loan Sales
            
            173,704
            
            
            
            176,919
            
            
            
            259,285Loss
                (Gain) on Sale of Other Real Estate Owned
            
            (75
            )
            
            
            26
            
            
            
            73Share-based
                compensation expense
            
            1,113
            
            
            
            -
            
            
            
            -Net
                Increase in Cash Surrender Value of Life Insurance
            
            (745
            )
            
            
            (507
            )
            
            
            (317
            )Federal
                Home Loan Bank Stock Dividends
            
            (97
            )
            
            
            (69
            )
            
            
            (40
            )Net
                Change in Accrued Interest, Other Assets and Other
                Liabilities
            
            (2,433
            )
            
            
            (1,429
            )
            
            
            1,882**NET
                CASH USED IN OPERATING ACTIVITIES**
            
            (62,381
            )
            
            
            (25,643
            )
            
            
            (5,164
            )**INVESTING
                ACTIVITIES**Purchases
                of Held-to-Maturity Investments
            
            (2,230
            )
            
            
            (1,194
            )
            
            
            (998
            )Proceeds
                from Maturities of Held-to-Maturity Securities
            
            1,201
            
            
            
            1,200
            
            
            
            1,000Purchases
                of Federal Reserve and Federal Home Loan Bank Stock
            
            (45
            )
            
            
            (652
            )
            
            
            (1,193
            )Proceeds
                from Sale of Federal Reserve Bank Stock
            
            1,245
            
            
            
            -
            
            
            
            -Net
                Increase in Loans
            
            (166,790
            )
            
            
            (183,664
            )
            
            
            (157,465
            )Purchase
                of loans
            
            (133,336
            )
            
            
            -
            
            
            
            -Purchases
                of Premises and Equipment
            
            (2,271
            )
            
            
            (1,727
            )
            
            
            (3,009
            )Proceeds
                from Sale of Premises and Equipment
            
            131
            
            
            
            129
            
            
            
            49Purchase
                of Cash Surrender Value Life Insurance
            
            (5,700
            )
            
            
            (7,490
            )
            
            
            (3,572
            )Proceeds
                from Sale of Other Real Estate Owned
            
            3,062
            
            
            
            647
            
            
            
            1,519**NET
                CASH USED IN INVESTING ACTIVITIES**
            
            (304,733
            )
            
            
            (192,751
            )
            
            
            (163,669
            )**FINANCING
                ACTIVITIES**Net
                Increase in Demand Deposits and Savings Accounts
            
            19,995
            
            
            
            30,908
            
            
            
            44,873Net
                Increase in Time Deposits
            
            319,074
            
            
            
            176,757
            
            
            
            106,407Net
                Change in Federal Home Loan Bank Advances
            
            (30,000
            )
            
            
            30,000
            
            
            
            -Proceeds
                from Issuance of Junior Subordinated Debt Securities
            
            12,372
            
            
            
            8,248
            
            
            
            8,248Proceeds
                from Private Placement Stock Offering, net
            
            25,137
            
            
            
            -
            
            
            
            -Proceeds
                from Exercise of Stock Options
            
            1,114
            
            
            
            876
            
            
            
            1,674Excess
                tax benefits from Exercise of Stock Options
            
            1,379
            
            
            
            -
            
            
            
            -**NET
                CASH PROVIDED BY FINANCING ACTIVITIES**
            
            349,071
            
            
            
            246,789
            
            
            
            161,202**INCREASE
                (DECREASE) IN CASH AND CASH EQUIVALENTS**
            
            (18,043
            )
            
            
            28,395
            
            
            
            (7,631
            )Cash
                and Cash Equivalents at Beginning of Year
            
            51,512
            
            
            
            23,117
            
            
            
            30,748**CASH
                AND CASH EQUIVALENTS AT END OF YEAR**
            $
            33,469
            
            
            $
            51,512
            
            
            $
            23,117**Supplemental
                Disclosures of Cash Flow Information:**Interest
                Paid
            $
            33,312
            
            
            $
            14,032
            
            
            $
            6,287Income
                Taxes Paid, net of refunds
            $
            9,307
            
            
            $
            13,794
            
            
            $
            8,469Transfer
                of Loans to Other Real Estate Owned
            $
            2,131
            
            
            $
            2,482
            
            
            $
            1,410





See
      accompanying notes to the consolidated financial statements


65


**TEMECULA
      VALLEY BANCORP INC.**


**NOTES
      TO THE CONSOLIDATED FINANCIAL
      STATEMENTS**


December
      31, 2006, 2005, and 2004





**NOTE
      A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**





**Principles
      of Consolidation**





On
      June
      3, 2002, Temecula Valley Bancorp Inc. acquired all the outstanding shares of
      Temecula Valley Bank by issuing 7,346,406 shares of common stock in exchange
      for
      the surrender of all outstanding shares of Temecula Valley Bank’s common stock.
      There was no cash involved in this transaction. The acquisition was accounted
      for as a reverse merger. The consolidated financial statements contained herein
      have been restated to give full effect to this transaction. 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 ten full-service
      banking offices located in Carlsbad, Corona, El Cajon, Escondido, Fallbrook,
      Murrieta, Ontario, Solana Beach, 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.





On
      January 10, 2007, we announced plans to close loan production offices located
      in
      the northeast and southeast areas of the country. It is anticipated that this
      reorganization will result in cost savings greater than the income generated
      from the closed offices. As a result, we will 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, interest-earning deposits in other financial institutions, 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**





Prior
      to our withdrawal as a Federal Reserve Bank member in July 2006, we were
      required to maintain a percentage of our deposits as reserves in cash or on
      deposit with the Federal Reserve Bank. The average daily reserve requirement
      as
      of December 31, 2006 was zero. The average daily reserve requirement as of
      December 31, 2005 was $13.4 million. We complied with the reserve requirements
      as of December 31, 2006 and 2005.





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




66


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. A vailable-for-sale
      and held-to-maturity securities are assessed at each reporting date to determine
      whether there is an other-than-temporary impairment.





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, 2006, our FNMA mortgage-backed security, with an amortized cost
      and
      fair value of $1.0 million, was classified as held-to-maturity. This security
      was purchased on November 8, 2006 and matures in 2036.





**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 8% and 10% 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 5%
      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**





In
      April
      2006, we began purchasing participations in the unguaranteed portions of SBA
      7(a) loans to be held in our loan portfolio (“purchase program”). The
      purchase program has low acquisition costs and enables us to further leverage
      our SBA expertise. The participations are purchased based upon their payment
      history and other selected underwriting criteria.  We feel that the
      addition of the purchase program will enable us to further diversify our loan
      portfolio by adding more small business borrowers who are located throughout
      the
      United States. At December 31, 2006, we had $120.3 million in outstanding
      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.





67


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, 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
      Assets and Interest-Only Strips Receivable**





Servicing
      assets represent the allocated value of retained servicing rights on loans
      sold.
      Servicing assets are expensed in proportion to, and over the period of,
      estimated net servicing revenues. Impairment is evaluated based on stratifying
      the underlying financial assets by date of origination and term. Fair value
      is
      determined using prices for similar assets with similar characteristics, when
      available, or based upon discounted cash flows using market-based assumptions.
      Any impairment, if temporary, of a grouping is reported as a valuation
      allowance, to the extent that fair value is less than the capitalized amount
      for
      the grouping. The portion of servicing fees in excess of the contractual
      servicing fees is reflected as interest-only (I/O) strips receivable, which
      are
      classified as available-for-sale and are carried at fair value.





Rights
      to
      future interest income from serviced loans that exceed contractually specified
      servicing fees are classified as interest-only strips. The interest-only strips
      are classified as available-for-sale and recorded at fair value with any
      unrealized gains or losses recorded through other comprehensive income in the
      period of change of fair value. Declines in fair value of I/O strips below
      their
      cost that are other than temporary are reflected as realized losses through
      the
      income statement. In estimating other-than-temporary losses, management
      considers the length of time and extent that fair value has been less than
      cost.
      In addition, management analyzes the underlying assumptions that caused the
      unrealized loss and the likelihood of such assumptions to recover to levels
      used
      to determine the amortized cost basis.





**Loan
      Sales Recognition**





Statement
      of Financial Accounting Standards (“SFAS”) No. 140, *“Accounting
      for Transfers and Servicing of Financial Assets and Extinguishments of
      Liabilities”,* provides
      accounting and reporting standards for transfers and servicing of financial
      assets and extinguishments of liabilities. ** Under
      this statement 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.




68


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. Company owned
      life
      insurance (or Bank owned life insurance “BOLI”) is recorded at its cash
      surrender value or the amount that can be realized.





**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”* .
      This
      Statement supersedes Accounting Principles Board ("APB") Opinion No. 25,
“ *Accounting
      for Stock Issued to Employees”* and its
      related implementation guidance and is a revision of SFAS No. 123, “ *Accounting
      for Stock-Based Compensation”.* SFAS
      No.
      123R establishes standards for the accounting of transactions in which an entity
      exchanges its equity instruments for goods or services. It also addresses
      transactions in which an entity incurs liabilities in exchange for goods or
      services that are based on the fair value of the entity's
      equity instruments or that may be settled by the issuance of those equity
      instruments. This Statement focuses primarily on accounting for transactions
      in
      which an entity obtains employee services in share-based payment transactions. SFAS
        No. 123R
        requires companies to measure the cost of employee services received in exchange
        for award of equity instruments based on the grant-date fair value of the
        award.
        That cost is recognized over the period during which an employee is required
        to
        provide service in exchange for the award - the requisite service period
        (usually the vesting period). This applies to awards granted or modified
        on or
        after January 1, 2006 and grants that vest on or after January 1,
        2006.
 69


SFAS
      No.
      123R allows for two alternative transition methods. We elected to follow the
      modified-prospective transition method, which requires application of the new
      statement to new awards and to awards modified, repurchased, or cancelled after
      the required effective date. Prior periods were not restated to reflect the
      impact of adopting the new standard. Additionally, the compensation cost for
      the
      portion of awards for which the requisite service has not been rendered, that
      were outstanding as of the required effective date, will be recognized as the
      requisite services are rendered on or after the effective date. The compensation
      cost of that portion of awards will be based on the grant-date fair value of
      those awards as calculated for pro-forma disclosures under the original SFAS
      No.
      123.





As
      a result of the adoption of SFAS No. 123R, we have recognized compensation
      expense for awards on a straight-line basis over the vesting period of the
      award. For 2006, the adoption of this standard resulted in a reduction of income
      before taxes of $1.1 million, a reduction in net income of $659 thousand,
      decrease in basic and diluted earnings per share of $0.07, an increase in cash
      flow from operations of $1.1 million, and an increase in cash flows from
      financing activities of $1.4 million.




There
      was approximately $1.2 million of total
      unrecognized compensation expense for non-vested options granted under all
      of
      our plans as of December 31, 2006.




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
      years ended December 31, 2005 and 2004.


2005
            
            2004(dollars
                in thousands)Net
                income, as reported
            $
            13,953
            
            
            $
            10,578Deduct:
                Total stock-based employee compensation expensedetermined
                under fair value based method for all awards,net
                of related tax effects
            
            (488
            )
            
            
            (342
            )Pro
                Forma Net Income
            $
            13,465
            
            
            $
            10,236Per
                Share Data:Basic
                income per share, as reported
            $
            1.58
            
            
            $
            1.24Basic
                income per share, proforma
            $
            1.52
            
            
            $
            1.20Diluted
                income per share, as reported
            $
            1.46
            
            
            $
            1.13Diluted
                income per share, proforma
            $
            1.40
            
            
            $
            1.09





**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.





**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.




70


**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**





Comprehensive
      income consists of net income and other comprehensive income. Other
      comprehensive income includes unrealized gains and losses on interest-only
      strips. 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
      September 2006, the Financial Accounting Standards Board (“FASB”) issued
      Statement of Financial Accounting Standards No. 158, *“Employers'
      Accounting for Defined Benefit Pension and Other Postretirement Plans - an
      amendment of FASB Statements No. 87, 88, 106, and 132(R)”* (“SFAS
      158”). SFAS No. 158 requires an employer to recognize a plan's overfunded or
      underfunded status in its balance sheets and recognize the changes in a plan's
      funded status in comprehensive income in the year in which the changes occur.
      In
      addition, SFAS No. 158 requires an employer to measure plan assets and
      obligations that determine its funded status as of the end of its fiscal year.
      The requirement to recognize the funded status of a benefit plan and the
      disclosure requirements are effective as of the end of the fiscal year ending
      after December 15, 2006. The requirement
      to measure plan assets and benefit obligations as of the employer’s fiscal
      year-end is effective for fiscal years ending after December 15, 2008. The
      adoption of SFAS No. 158 had no impact on our financial condition or results
      of
      operations.





71


In
      September 2006, the SEC issued Staff Accounting Bulletin No. 108 *“Considering
      the Effects of Prior Year Misstatements when Quantifying Misstatements in
      Current Year Financial Statements”* (“SAB
      108”) *.* SAB 108
      requires the evaluation of prior-year misstatements using both the balance
      sheet
      approach and the income statement approach. In the initial year of adoption
      should either approach result in quantifying an error that is material in light
      of quantitative and qualitative factors, SAB 108 guidance allows for a one-time
      cumulative-effect adjustment to beginning retained earnings. In years subsequent
      to adoption, previously undetected misstatements deemed material shall result
      in
      the restatement of previously issued financial statements in accordance with
      FAS
      154. SAB 108 is effective for fiscal years ending on or after November 15,
      2006. The adoption of SAB 108 had no impact on our financial condition or
      results of operations.





In
      November 2005, the FASB issued Staff Position (“FSP”) Nos. FAS 115-1 and 124-1
      to address the determination as to when an investment is considered impaired,
      whether that impairment is other than temporary and the measurement of an
      impaired loss. This FSP nullified certain requirements of Emerging Issues
      Task Force 03-1 *“The
      Meaning of Other-Than-Temporary Impairment and Its Application to Certain
      Investments”* (EITF
      03-1), and references existing guidance on other than temporary impairment.
      Furthermore, this FSP creates a three step process in determining when an
      investment is considered impaired, whether that impairment is other than
      temporary, and the measurement of an impairment loss. The FSP is effective
      for reporting periods beginning after December 15, 2005. The adoption did
      not have a material impact on our financial condition or results of
      operations.





In
      May
      2005, the FASB issued SFAS No. 154, *“Accounting
      Changes and Error Corrections”* ,
      which
      addresses accounting for changes in accounting principle; changes in accounting
      estimates, changes required by an accounting pronouncement in the instance
      that
      the pronouncement does not include specific transition provisions and error
      correction. SFAS No. 154 requires retrospective application to prior
      periods’ financial statements of changes in accounting principle and error
      correction unless impracticable to do so. SFAS No. 154 states an exception
      to
      retrospective application when a change in accounting principle, or the method
      of applying it, may be inseparable from the effect of a change in accounting
      estimate. When a change in principle is inseparable from a change in
      estimate, such as depreciation, amortization or depletion, the change to the
      financial statements is to be presented in a prospective manner. SFAS No.
      154 and the required disclosures are effective for accounting changes and error
      corrections in fiscal years beginning after December 15, 2005. The adoption
      of
      this standard did not have a significant impact on our financial condition
      or
      results of operations.





In
      December 2004, the FASB issued Statement of Financial Accounting Standards
      (“SFAS”) No. 123R, “ *Share-Based
      Payment”* .
      Effective January 1, 2006, we adopted SFAS No. 123R. See “Stock-Based
      Compensation” above.





**Effect
      of Newly Issued but Not Yet Effective Accounting
      Standards**





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.
      We are currently assessing the financial impact this Statement will have 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.





72


In
      March
      2006, the FASB issued SFAS No. 156, *“Accounting
      for Servicing of Financial Assets - an amendment of FASB statement
      No.140”* , *“Accounting
      for Transfers and Servicing of Financial Assets and Extinguishments of
      Liabilities”* .
      SFAS
      No. 156 clarifies when a servicer should separately recognize servicing assets
      and servicing liabilities and permits an entity to choose either the
“Amortization Method” or “Fair Value Measurement Method” for subsequent
      measurement of each class of such assets and liabilities. SFAS No. 156 is
      effective as of the beginning
      of an entity’s first fiscal year that begins after September 15, 2006. Earlier
      adoption is permitted as of the beginning of an entity’s fiscal year, provided
      the entity has not issued financial statements. We will implement this standard
      as of the beginning of our fiscal year 2007. We will use the “fair value
      measurement method” to account for our servicing upon adoption. We do not expect
      that the adoption of this standard will have a significant impact on our
      financial condition or results of operations.





In
      February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid
      Financial Instruments”. SFAS No. 155, amends SFAS No. 133, “Accounting for
      Derivative Instruments and Hedging Activities”, and SFAS 140, “Accounting for
      Transfers of Financial Assets and Extinguishments of Liabilities”. SFAS No. 155
      allows financial instruments that have embedded derivatives to be accounted
      for
      as a whole (eliminating the need to bifurcate the derivative from its host)
      if
      the holder elects to account for the whole instrument on a fair value basis.
      SFAS No. 155 also clarifies and amends certain other provisions of SFAS No.
      133
      and SFAS No. 140 that identifies which interest-only strips are not subject
      to
      the requirements of SFAS No. 133. This statement is effective for all financial
      instruments acquired or issued after January 1, 2007 with earlier adoption
      permitted. This statement will impact the way we account for I/O strips
      requiring us to record these assets at fair value with all adjustments running
      through the income statement for new I/O strips acquired after the
      implementation date.





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. 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. The adoption
      of this standard will not have a significant impact on our financial condition
      or results of operations.





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. As of September
      20, 2006, this FASB board ratified the above. It is applicable for fiscal years
      beginning after December 15, 2006. We are currently assessing the impact that
      EITF 06-4 will have on our financial condition or results of
      operations.





Under
      EITF 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"* ,
      the
      Task Force reached a consensus that a policyholder should consider any
      additional amounts included in the contractual terms of the policy in
      determining the amount that could be realized under the insurance contract.
      The
      task forces agreed that contractual limitations should be considered when
      determining the realizable amounts. Those amounts that are recoverable by the
      policyholder at the discretion of the insurance company should be excluded
      from
      the amount that could be realized. The Task Force also agreed that fixed amounts
      that are recoverable by the policyholder in future periods in excess of one
      year
      from the surrender of the policy should be recognized at their present value.
      The Task Force also reached a consensus that a policyholder should determine
      the
      amount that could be realized under the life insurance contract assuming the
      surrender of an individual -life by individual life policy. The Task Force
      also
      noted that any amount that is ultimately realized by the policyholder upon
      the
      assumed surrender of the final policy shall be included in the amount that
      could
      be realized under the insurance contract. The issue should be effective for
      fiscal years beginning after December 15, 2006, but early adoption is permitted.
      The adoption of this EITF will not have a significant impact on our financial
      condition or results of operations.





73


**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, 2006 and 2005, $46.6 million and $47.8 million of loans and loans
      held-for-sale were guaranteed under these programs.





**NOTE
      C - ALLOWANCE FOR LOAN LOSSES**





A
      summary
      of the changes in the allowance for loan losses as of December 31 2006, 2005,
      and 2004 follows:





2006
            
            
            2005
            
            
            2004(dollars
                in thousands)Balance
                at Beginning of Year
            $
            9,039
            
            
            $
            6,362
            
            
            $
            3,608Additions
                to the Allowance Charged to Expense
            3,650
            
            
            
            2,897
            
            
            
            3,821Recoveries
                on Loans Charged Off
            
            214
            
            
            
            320
            
            
            
            3012,903
            
            
            
            9,579
            
            
            
            7,459Loans
                Charged Off
            
            (381
            )
            
            
            (540
            )
            
            
            (1,097
            )$
            12,522
            
            
            $
            9,039
            
            
            $
            6,362




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, 2006, 2005, and 2004:





2006
            
            2005
            
            2004(dollars
                in thousands)Recorded
                Investment in Nonperforming Loans
            $
            19,124
            
            
            $
            7,951
            
            
            $
            11,799Guaranteed
                Portion of Nonperforming Loans
            
            (10,335
            )
            
            
            (6,514
            )
            
            
            (8,140
            )Net
                Non-Performing Loans
            $
            8,789
            
            
            $
            1,437
            
            
            $
            3,659Net
                impaired loans with allocated allowance for loan loss
            $
            2,436
            
            
            $
            825
            
            
            $
            904Related
                Allowance for Impaired Loans
            $
            615
            
            
            $
            176
            
            
            $
            221Average
                Recorded Net Investment in Nonperforming Loans
            $
            3,509
            
            
            $
            2,438
            
            
            $
            2,249Interest
                Income Recognized for Cash Payments
            
            None
            
            
            
            None
            
            
            
            NoneInterest
                Income Foregone on Nonaccrual Loans
            $
            1,974
            
            
            $
            898
            
            
            $
            549Total
                Loans Past-Due Ninety Daysor
                More and Still Accruing
            $
            140
            
            
            $
            -
            
            
            $
            -





**NOTE
      D - SERVICING ASSETS AND INTEREST-ONLY STRIPS
      RECEIVABLE**





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%. At December 31,
      2004, we were servicing approximately $357.7 million of the guaranteed portion
      of 7(a) loans previously sold with a weighted-average servicing and I/O rate
      of
      2.83%. The cash collected from servicing is used to cover the operating expenses
      of servicing the portfolio, as well as covering the amortization of the
      servicing asset. 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, 2006, 2005, and 2004, are as follows:




74


Servicing
                Assets2006
            
            2005
            
            2004(dollars
                in thousands)Balance
                at Beginning of Year
            $
            8,169
            
            
            $
            7,586
            
            
            $
            6,117Increase
                from Loan Sales
            
            2,378
            
            
            
            2,598
            
            
            
            3,731Amortization
                Charged to Income
            
            (2,259
            )
            
            
            (2,015
            )
            
            
            (2,262
            )Balance
                at End of Year
            $
            8,288
            
            
            $
            8,169
            
            
            $
            7,586Interest-Only
                Strips Receivable2006
            
            2005
            
            2004(dollars
                in thousands)Balance
                at Beginning of Year
            $
            22,068
            
            
            $
            24,680
            
            
            $
            20,496Increase
                from Loan Sales
            
            1,377
            
            
            
            2,160
            
            
            
            8,041Amortization
                Charged to Income
            
            (9,228
            )
            
            
            (5,478
            )
            
            
            (3,857
            )Fair
                Market value adjustment
            
            (1,002
            )
            
            
            706
            
            
            
            -Balance
                at End of Year
            $
            13,215
            
            
            $
            22,068
            
            
            $
            24,680





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. At December 31, 2004, there was no unrealized gain or loss.
      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.




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 review the
      servicing asset for possible impairment and 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, 2006 and
      2005.





SBA
                Pools - Constant Prepayment RatesVariable
                Rate PoolsDecember
                31,2006
            
            2005Year
            <
                8 Yr Life CPR
            8-11
                Yr Life CPR
            11-16
                Yr Life CPR
            16-21
                Yr Life CPR
            >
                21 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
            8.35
            6.01
            5.71
            4.29
            4.55
            
            16.30
            13.50
            14.10
            12.50
            13.70Year
                2
            14.42
            11.66
            10.34
            12.65
            10.05
            
            16.60
            14.90
            13.10
            14.90
            15.40Year
                3
            18.53
            16.70
            15.68
            16.81
            17.62
            
            15.90
            14.40
            15.10
            16.60
            16.30Year
                4
            18.91
            17.70
            18.99
            19.99
            21.78
            
            15.70
            14.90
            15.70
            15.30
            16.80Year
                5
            16.61
            16.17
            18.91
            20.00
            21.27
            
            13.60
            14.40
            16.90
            14.80
            17.50Year
                6
            14.75
            16.20
            18.17
            17.68
            20.60
            
            13.40
            13.80
            15.30
            16.70
            18.10Year
                7
            11.98
            14.28
            18.08
            18.96
            19.02Year
                8
            7.20
            11.03
            13.05
            14.68
            19.30Year
                9
            3.70
            9.13
            12.83
            19.47
            19.30Year
                10
            1.40
            5.20
            12.65
            14.25
            20.45Year
                11+
            0.00
            2.30
            11.90
            9.90
            22.20





The
      value
      of the servicing asset would decrease $1.2 million if prepayment speeds
      increased 10% and the value of the servicing asset would decrease $2.3 million
      if prepayment speeds increased 20%.




The
      expected overall average life of the servicing portfolio is 3.82 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, 2006 and 2005 based on assessing each
      component.





75


December
                31,2006
            
            2005Original
                Maturity
            Disc
                Rate
            
            Disc
                Rate<
                8
            Years
            8.94%
            
            9.40%8-11
            Years
            8.84%
            
            9.40%11-16
            Years
            8.77%
            
            9.37%16-21
            Years
            8.72%
            
            9.36%>
                21
            Years
            8.73%
            
            9.35%





The
      servicing asset value would decrease $624 thousand if the discount rate
      increased 1% and the servicing asset value would decrease $1.2 million 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. The approximate future amortization expense
      on servicing assets and I/O strips receivable for the next 3 years is as
      follows:


Year
            (dollars
                in thousands)2007
            $
            8,2802008
            
            7,6822009
            
            5,542$
            21,504





**NOTE
      E - PREMISES AND EQUIPMENT**





A
      summary
      of premises and equipment as of December 31, 2006 and 2005 follows:





2006
            
            2005(dollars
                in thousands)Land
            $
            500
            
            
            $
            500Buildings
                and Leasehold Improvements
            
            2,294
            
            
            
            1,909Autos
            
            1,560
            
            
            
            1,547Furniture,
                Fixtures, and Equipment
            
            5,960
            
            
            
            4,51610,314
            
            
            
            8,472Accumulated
                Depreciation and Amortization
            
            (4,822
            )
            
            
            (3,587
            )$
            5,492
            
            
            $
            4,885





Depreciation
      and amortization expense for premises and equipment was $1.5 million in 2006,
      $1.1 million in 2005, and $766 thousand in 2004.





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 $1.9 million in 2006,
      $1.5
      million in 2005, and $1.1 million in 2004. The approximate future minimum annual
      payments for these leases by year are as follows:


Year
            
            (dollars
                in thousands)2007
            $
            1,8312008
            
            1,4852009
            
            9162010
            
            5422011
            
            337Thereafter
            
            381$
            5,492





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


76


**NOTE
      F - DEPOSITS**





At
      December 31, 2006 the scheduled maturities of time deposits are as
      follows:





Year
            (dollars
                in thousands)2007
            $
            773,6852008
            
            2,4582009
            
            3412010
            
            1042011
            
            250$
            776,838





Our
      five
      largest depositors had approximately $35.5 million and $22.6 million on deposit
      (excluding brokered deposits) at December 31, 2006 and 2005, respectively.
      Brokered deposits were $47.2 million at December 31, 2006. We had no brokered
      deposits at December 31, 2005.





**NOTE
      G - FHLB ADVANCES AND OTHER BORROWINGS**





At
      December 31, 2006, there were no borrowings from the Federal Home Loan Bank
      (“FHLB”). On December 31, 2005, we had a FHLB advance of $30.0 million which
      matured on January 3, 2006 and accrued interest at 4.21%. We are required to
      pledge a certain amount of loans with the FHLB for collateralization purposes.
      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.
      As
      of December 31, 2005, $65.7 million in loans was pledged for an aggregate
      borrowing line of $30.1 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 $38.0 million as of December 31, 2006. As of December 31,
      2006 and 2005, 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 table below summarizes the terms of each issuance of our junior
      subordinated debt securities at December 31, 2006.





Series
            Amount
              (000’s)
            
            Date Issued
            
            Rate
                Adjustor
            
            Effective
                Rate
            
            Maturity
                DateTemecula
                Valley Statutory Trust I
            $
            7,217
            
            June
                2002
            
            3-month
                LIBOR +3.45%
            
            8.82%
            
            2032Temecula
                Valley Statutory Trust II
            
            5,155
            
            September
                2003
            
            3-month
                LIBOR +2.95%
            
            8.31%
            
            2033Temecula
                Valley Statutory Trust III
            
            8,248
            
            September
                2004
            
            3-month
                LIBOR +2.20%
            
            7.57%
            
            2034Temecula
                Valley Statutory Trust IV
            
            8,248
            
            September
                2005
            
            3-month
                LIBOR +1.40%
            
            6.76%
            
            2035Temecula
                Valley Statutory Trust V
            
            12,372
            
            September
                2006
            
            3-month
                LIBOR +1.60%
            
            6.96%
            
            2036Total
            $
            41,240





We
      also
      purchased a 3% minority interest in Temecula Valley Statutory Trusts I, II,
      III,
      IV, and V. The balance of the equity of Temecula Valley Statutory Trusts I,
      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 I, 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, 2006, 2005,
      and 2004 we have included the net junior subordinated debt in our capital for
      regulatory capital purposes.


77


**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 $486 thousand in 2006, $395 thousand in 2005, and
      $312
      thousand in 2004.





We
      have
      entered into retirement benefit agreements with certain officers providing
      for
      future benefits aggregating approximately $18.7 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 $654 thousand, $723 thousand, and $1.1 million, for the years ended
      December 31, 2006, 2005, and 2004, respectively. As of December 31, 2006 and
      2005, $3.3 million and $2.9 million has been accrued in conjunction with these
      agreements. Amounts
      paid under these agreements totaled $215 thousand and $185 thousand in 2006
      and
      2005, respectively. 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. As of December 31, 2006, $150 thousand has been
      contributed to the ESOP. Currently, we plan to have the ESOP non-leveraged.
      As
      of December 31, 2006, the ESOP owns 7,038 shares of common stock acquired in
      the
      private placement stock offering 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:






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




78


**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
                31,2006
            
            2005
            
            2004Current:
            (dollars
                in thousands)Federal
            $
            10,917
            
            
            $
            8,686
            
            
            $
            7,040State
            
            3,060
            
            
            
            2,870
            
            
            
            2,47413,977
            
            
            
            11,556
            
            
            
            9,514Deferred
            
            (2,314
            )
            
            
            (1,670
            )
            
            
            (1,978
            )$
            11,663
            
            
            $
            9,886
            
            
            $
            7,536




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 2006, 2005, and 2004:


December
                31,2006
            
            2005
            
            2004Amount
            
            Percent
                of Pretax Income
            
            
            Amount
            
            Percent
                of Pretax Income
            
            
            Amount
            
            Percent
                of Pretax Income(dollars
                in thousands)Federal
                Tax Rate
            $
            10,004
            
            
            35.0%
            
            
            $
            8,344
            
            
            35.0%
            
            
            $
            6,159
            
            
            34.0%State
                Income Taxes, Net of Federal Income Tax Benefit
            
            1,619
            
            
            5.6%
            
            
            
            1,656
            
            
            7.0%
            
            
            
            1,282
            
            
            7.1%Income
                from Cash Surrender Value of Life Insurance
            
            (261
            )
            
            (0.9%
            )
            
            
            (177
            )
            
            (0.7%
            )
            
            
            (108
            )
            
            (0.6%
            )Meals
                & Entertainment
            
            73
            
            
            0.3%
            
            
            
            53
            
            
            0.2%
            
            
            
            -
            
            
            0.0%Incentive
                Stock Option Expense
            
            265
            
            
            0.9%
            
            
            
            21
            
            
            0.1%
            
            
            
            -
            
            
            0.0%Other
                Items, Net
            
            (37
            )
            
            (0.1%
            )
            
            
            (11
            )
            
            (0.1%
            )
            
            
            203
            
            
            1.1%Total
            $
            11,663
            
            
            40.8%
            
            
            $
            9,886
            
            
            41.5%
            
            
            $
            7,536
            
            
            41.6%





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




December
                31,2006
            
            2005Net
                Deferred Tax Assets
            (dollars
                in thousands)Allowance
                for Loan Losses
            $
            5,175
            
            
            $
            3,640Deferred
                Compensation Plans
            
            1,675
            
            
            
            1,374NQ
                Stock Option Expense
            
            150
            
            
            
            -State
                Taxes
            
            974
            
            
            
            996Non-accrual
                Interest
            
            492
            
            
            
            221Unrealized
                Loss on I/O Strip Receivable
            
            125
            
            
            
            -Other
                Assets
            
            213
            
            
            
            88,804
            
            
            
            6,239Deferred
                Tax Liabilities:Depreciation
                Differences
            
            (74
            )
            
            
            (69
            )Unrealized
                Gain on I/O Strip Receivable
            
            -
            
            
            
            (297
            )Other
                Liabilities
            
            (250
            )
            
            
            (129
            )(324
            )
            
            
            (495
            )Net
                Deferred Tax Assets
            $
            8,480
            
            
            $
            5,744





At
      December 31, 2006 and 2005, there was no valuation allowance recorded against
      the net deferred tax asset.


79


**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,
      2006, 2005, and 2004:





2006
            
            2005
            
            2004Income
            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
            $
            16,920
            
            
            
            
            
            
            $
            13,953
            
            
            
            
            
            
            $
            10,578Weighted
                Average Shares Outstanding During the Year
            
            
            9,235
            
            
            
            
            
            
            
            8,846
            
            
            
            
            
            
            
            8,503Used
                in Basic EPS
            
            16,920
            9,235
            
            $
            1.83
            
            
            
            13,953
            8,846
            
            $
            1.58
            
            
            
            10,578
            8,503
            
            $
            1.24Dilutive
                Effect of Stock Options and Warrants
            
            
            563
            
            
            (0.10
            )
            
            
            
            743
            
            
            (0.12
            )
            
            
            
            861
            
            
            (0.11
            )Used
                in Dilutive EPS
            $
            16,920
            9,798
            
            $
            1.73
            
            
            $
            13,953
            9,589
            
            $
            1.46
            
            
            $
            10,578
            9,364
            
            $
            1.13





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





**NOTE
      L - STOCK OPTION PLAN**





At
      December 31, 2006, 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, 2006,
      there were 193,084 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.





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 2006 was $7.06.
      The weighted-average grant-date fair value of options granted during 2005 was
      $5.90. The weighted-average grant-date fair value of options granted during
      2004
      was $5.07. 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
                31,2006
            
            2005
            
            2004Expected
                life (years)
            4
            
            5
            
            5Risk
                free interest rate
            4.39%
            
            4.36%
            
            3.61%Weighted
                Average Expected volatility
            29.29%
            
            24.30%
            
            27.90%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, 2006, is presented below:




80


Stock
                Options
            
            Weighted
                Average Exercise Price
            
            Aggregate
                Intrinsic Value
            
            Weighted
                Average Remaining Contractual LifeOutstanding
                as of 01/01/2006
            1,576,961
            
            
            $
            7.41Granted
            149,000
            
            
            $
            20.78Exercised
            (288,393
            )
            
            $
            3.87Forfeited,
                expired or cancelled
            (24,170
            )
            
            $
            17.76Outstanding
                as of 12/31/2006
            1,413,398
            
            
            $
            9.36
            
            $
            19,985,448
            
            5.26Shares
                exercisable as of 12/31/2006
            1,137,324
            
            
            $
            6.98
            
            $
            18,788,592
            
            4.46





Tax
      benefits recognized in income tax expense relative to the vesting of
      nonqualified stock options were $150 thousand in 2006. 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 2006 was 3.18%. The total intrinsic value of options
      exercised during 2006 and 2005 was $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,
      2006, that subsequently vest will result in net compensation costs of
      approximately $663 thousand in 2007, $361 thousand in 2008, and $102 thousand
      in
      2009.





**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 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, 2006
      and
      2005, we had the following outstanding financial commitments whose contractual
      amount represents credit risk:


December
                31, 2006
            
            December
                31, 2005Fixed
            
            
            Variable
            
            
            Total
            
            
            Fixed
            
            
            Variable
            
            
            Total(dollars
                in thousands)Commitments
                to Extend Credit
            $
            3,331
            
            $
            395,023
            
            $
            398,354
            
            $
            4,408
            
            $
            377,195
            
            $
            381,603Letters
                of Credit
            
            -
            
            
            3,514
            
            
            3,514
            
            
            10
            
            
            4,765
            
            
            4,775Loan
                Commitments Outstanding
            $
            3,331
            
            $
            398,537
            
            $
            401,868
            
            $
            4,418
            
            $
            381,960
            
            $
            386,378





The
      fixed
      rate loan commitments have interest rates ranging from 6.12% to 11.25% as of
      December 31, 2006 and 7.75% to 9.25% as of December 31, 2005.





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.





81


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.





***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, 2006, and
      2005 is summarized as follows:




2006
            
            2005Carrying
                Value
            
            Fair
                Value
            
            
            Carrying
                Value
            
            Fair
                ValueFinancial
              Assets:
            (dollars
                in thousands)Cash
                and Due From Banks
            $
            15,190
            
            $
            15,190
            
            $
            18,312
            
            $
            18,312Interest-bearing
                deposits with other Financial Institutions
            99
            
            
            99
            
            
            -
            
            
            -Federal
                Funds Sold
            
            18,180
            
            
            18,180
            
            
            33,200
            
            
            33,200FNMA
                MBS (held-to-maturity)
            
            1,019
            
            
            1,029
            
            
            -
            
            
            -Loans
                Held for Sale
            
            173,120
            
            
            173,120
            
            
            82,813
            
            
            82,813Loans,
                net
            
            957,051
            
            
            952,565
            
            
            661,394
            
            
            659,580Federal
                Reserve & FHLB Stock
            1,996
            
            
            1,996
            
            
            3,099
            
            
            3,099I/O
                Strips Receivable and Servicing Assets
            21,503
            
            
            21,503
            
            
            30,237
            
            
            30,878Accrued
                Interest Receivable
            6,155
            
            
            6,155
            
            
            3,472
            
            
            3,472Financial
                Liabilities:Deposits
            
            1,081,501
            
            
            1,081,598
            
            
            742,432
            
            
            742,425FHLB
                Advances
            
            -
            
            
            -
            
            
            30,000
            
            
            30,000Junior
                Subordinated Debt
            
            41,240
            
            
            41,240
            
            
            28,868
            
            
            28,868Accrued
                Interest Payable
            
            2,094
            
            
            2,094
            
            
            957
            
            
            957





82


**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, 2006, 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, 2006:
            (dollars
                in thousands)Total
                Capital (to Risk-Weighted Assets)
            $
            154,976
            
            12.40%
            
            $
            99,994
            
            8.00%Tier
                1 Capital (to Risk-Weighted Assets)
            $
            136,579
            
            10.93%
            
            $
            49.997
            
            4.00%Tier
                1 Capital (to Average Assets)
            $
            136,579
            
            11.42%
            
            $
            47,848
            
            4.00%As
                of December 31, 2005:Total
                Capital (to Risk-Weighted Assets)
            $
            94,422
            
            11.02%
            
            $
            68,553
            
            8.00%Tier
                1 Capital (to Risk-Weighted Assets)
            $
            76,484
            
            8.93%
            
            $
            34,276
            
            4.00%Tier
                1 Capital (to Average Assets)
            $
            76,484
            
            9.28%
            
            $
            32,970
            
            4.00%





As
      of
      December 31, 2006, 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, 2006:
            (dollars
                in thousands)Total
                Capital
              (to
                Risk-Weighted Assets)
            $
            145,702
            
            11.67%
            
            $
            99,889
            
            8.00%
            
            $
            124,861
            
            10.00%Tier
                1 Capital
              (to
                Risk-Weighted Assets)
            $
            133,160
            
            10.66%
            
            $
            49,944
            
            4.00%
            
            $
            74,917
            
            6.00%Tier
                1 Capital
              (to
                Average Assets)
            $
            133,160
            
            11.16%
            
            $
            47,740
            
            4.00%
            
            $
            59,675
            
            5.00%As
                of December 31, 2005:Total
                Capital
              (to
                Risk-Weighted Assets)
            $
            92,550
            
            10.81%
            
            $
            68,472
            
            8.00%
            
            $
            85,590
            
            10.00%Tier
                1 Capital
              (to
                Risk-Weighted Assets)
            $
            83,491
            
            9.75%
            
            $
            34,236
            
            4.00%
            
            $
            51,354
            
            6.00%Tier
                1 Capital
              (to
                Average Assets)
            $
            83,491
            
            10.17%
            
            $
            32,842
            
            4.00%
            
            $
            41,053
            
            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.





83


**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 CONDITION**
            
            December
                31,2006
            
            2005ASSETS:
            
            (dollars
                in thousands)Cash
            
            $
            9,322
            
            
            $
            2,057Investment
                in Temecula Valley Statutory Trust I
            
            
            217
            
            
            
            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
            
            
            
            -Investment
                in Temecula Valley Bank
            
            
            133,989
            
            
            
            84,308Other
                Assets
            
            
            68
            
            
            
            138$
            144,619
            
            
            $
            87,371LIABILITIES
                AND SHAREHOLDERS' EQUITY:Other
                Liabilities
            
            $
            116
            
            
            $
            323Junior
                Subordinated Debt
            
            
            41,240
            
            
            
            28,868Shareholders'
                Equity
            
            
            103,263
            
            
            
            58,180$
            144,619
            
            
            $
            87,371




**CONDENSED
                STATEMENTS OF INCOME**
            
            Year
                Ended December 31,2006
            
            2005
            
            2004INCOME:
            
            (dollars
                in thousands)Cash
                Dividends from Statutory Trusts
            
            $
            73
            
            
            $
            41
            
            
            $
            20TOTAL
                INCOME
            
            
            73
            
            
            
            41
            
            
            
            20EXPENSES:Interest
                on Junior Subordinated Debt
            
            
            2,423
            
            
            
            1,450
            
            
            
            766Other
            
            
            288
            
            
            
            513
            
            
            
            403Income
                Tax Benefit
            
            
            (1,109
            )
            
            
            (808
            )
            
            
            (483
            )1,602
            
            
            
            1,155
            
            
            
            686LOSS
                BEFORE EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARY
            
            
            (1,529
            )
            
            
            (1,114
            )
            
            
            (666
            )EQUITY
                IN UNDISTRIBUTED INCOME OF SUBSIDIARY
            
            
            18,449
            
            
            
            15,067
            
            
            
            11,244NET
                INCOME
            
            $
            16,920
            
            
            $
            13,953
            
            
            $
            10,578**CONDENSED
                STATEMENTS OF CASH FLOWS**
            
            Year
                Ended December 31,2006
            
            2005
            
            2004CASH
                FLOWS FROM OPERATING ACTIVITIES:
            
            (dollars
                in thousands)Net
                income
            
            $
            16,920
            
            
            $
            13,953
            
            
            $
            10,578Noncash
                items included in net income:Equity
                in income of Subsidiary
            
            
            (18,449
            )
            
            
            (15,067
            )
            
            
            (11,244
            )Other
            
            
            871
            
            
            
            (8
            )
            
            
            974NET
                CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
            
            
            (658
            )
            
            
            (1,122
            )
            
            
            308CASH
                FLOWS FROM INVESTING ACTIVITIES:Investment
                in Subsidiaries
            
            
            (30,700
            )
            
            
            (7,000
            )
            
            
            (10,000
            )NET
                CASH USED IN INVESTING ACTIVITIES
            
            
            (30,700
            )
            
            
            (7,000
            )
            
            
            (10,000)
            )CASH
                FLOWS FROM FINANCING ACTIVITIES:Proceeds
                from Junior Subordinated Debt Securities
            
            
            12,372
            
            
            
            8,248
            
            
            
            8,248Proceeds
                from exercise of stock options
            
            
            1,114
            
            
            
            876
            
            
            
            1,674Proceeds
                from private placement stock offering, net
            
            
            25,137
            
            
            
            -
            
            
            
            -NET
                CASH PROVIDED BY FINANCING ACTIVITIES
            
            
            38,623
            
            
            
            9,124
            
            
            
            9,922NET
                INCREASE IN CASH AND CASH EQUIVALENTS
            
            
            7,265
            
            
            
            1,002
            
            
            
            230CASH
                AND CASH EQUIVALENTS AT BEGINNING OF YEAR
            
            
            2,057
            
            
            
            1,055
            
            
            
            825CASH
                AND CASH EQUIVALENTS AT END OF YEAR
            
            $
            9,322
            
            
            $
            2,057
            
            
            $
            1,055


84


******INDEX
      TO EXHIBITS**




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 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
                  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 by
                  reference).3.(ii)
            Bylaws
                of Temecula Valley Bancorp, as amended (included as an exhibit to
                Temecula
                Valley Bancorp’s Form 10-Q, filed on May 17, 2004, and incorporated herein
                by reference.)3.(iii)
            Bylaws
                amendment (included as an exhibit to Temecula Valley Bancorp’s Form 8-K
                filed on March 23, 2006).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 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 by reference).10.2
            Stephen
                H. Wacknitz Employment Agreement effective October 1, 2003 (included
                as an
                exhibit to Temecula Valley Bancorp’s Form 10-K filed on March 31, 2004,
                and incorporated by reference).#10.3
            First
                Amendment to Stephen H. Wacknitz Employment Agreement dated June
                23, 2005
                (included as an exhibit to Temecula Valley Bancorp’s Form 10Q, filed on
                August 9, 2005, and incorporated by reference). #10.3(a)
            Second
                Amendment to Stephen H. Wacknitz Employment Agreement dated February
                2,
                2006 (included as an exhibit to Temecula Valley Bancorp’s Form 10-K, filed
                on March 31, 2006, and incorporated by reference). #10.4
            Third
                Amendment to Stephen H. Wacknitz Employment Agreement dated December
                26,
                2006 (included as an exhibit to Temecula Valley Bancorp’s Form 8-K, filed
                on December 27, 2006, and incorporated by reference). #10.5
            Description
                of executive officer compensation (included with Temecula Valley
                Bancorp’s
                Form 8-K, filed on December 27, 2006, and incorporated by reference).
                #10.6
            401(k)
                (included with Temecula Valley Bancorp’s Form 10 K/SB, filed on April 16,
                2004, and incorporated by reference). #10.8
            Thomas
                P. Ivory Employment Agreement effective January 25, 2001 (included
                with
                Temecula Valley Bancorp’s Form 10-KS/B, filed on March 11, 2003, and
                incorporated by reference). #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
                by reference). #10.10
            First
                Amendment to James W. Andrews Employment Agreement dated November
                24, 2004
                (included in Temecula Valley Bancorp’s Form 10-K, filed on March 31, 2005,
                and incorporated by reference). #10.11
            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 incorporated 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 by
                reference). #




85


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 by reference). #10.12
            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 Form 10-K/SB, filed on April 11, 2003, and incorporated 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 by
                reference). #10.13
            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 incorporated
                by reference). #10.14
            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 by
                reference). #10.15
            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 by reference). #10.16
            The
                Executive Nonqualified Plan (included in Temecula Valley Bancorp's
                Form
                10-Q, filed on August 8, 2006, and incorporated by reference).
                #10.17
            Executive
                Deferred Compensation Agreement between Temecula Valley Bank and
                Thomas P.
                Ivory dated April 1, 2001 (included in Temecula Valley Bancorp’s Form
                10-Q/A., filed on November 18, 2004, and incorporated by reference).
                #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 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 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 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 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 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 by reference).
                #10.20
            Amended
                and Restated Salary Continuation Agreement between Temecula Valley
                Bank
                and Scott J. Word entered into December 29, 2006* which amends and
                restates Salary Continuation Agreement between Temecula Valley Bank
                and
                Scott J. Word dated September 30, 2004, (included in Temecula Valley
                Bancorp’s Form 10-Q/A, filed on November 18, 2004, and incorporated by
                reference). #10.21
            Split
                Dollar Agreement between Temecula Valley Bank and Thomas P. Ivory
                dated
                September 30, 2004, (included in Temecula Valley Bancorp’s Form 10-Q/A,
                filed on November 18, 2004, and incorporated by reference).*
                #10.21(a)
            First
                Amendment dated December 31, 2005 to Split Dollar Agreement between
                Temecula Valley Bank and Thomas P. Ivory dated September 30, 2004
                (included in Temecula Valley Bancorp’s Form 10-K, filed on March 31, 2006,
                and incorporated by reference). #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 by reference).**#**




86


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 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 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 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 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 by reference). #10.24
            Amended
                and Restated Split Dollar Agreement between Temecula Valley Bank
                and Scott
                J. Word entered into December 29, 2006* which amends and restates
                the
                Split Dollar Agreement between Temecula Valley Bank and Scott J.
                Word
                dated September 30, 2004 (included in Temecula Valley Bancorp’s Form
                10-Q/A, filed on November 18, 2004, and incorporated 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 by reference). #10.27
            Amended
                and Restated Salary Continuation Agreement between Temecula Valley
                Bank
                and Thomas M. Shepherd entered into December 29, 2006* which exhibit
                amends and restates the Amended and Restated Salary Continuation
                Agreement
                between Thomas M. Shepherd and Temecula Valley Bank dated September
                30,
                2004 (included in Temecula Valley Bancorp’s Form 10-K, filed on March 31,
                2005, and incorporated by reference). #10.28
            Amended
                and Restated Split Dollar Agreement between Temecula Valley Bank
                and
                Thomas M. Shepherd entered into December 29, 2006* which exhibit
                amends
                and restates the Split Dollar Agreement between Temecula Valley Bank
                and
                Thomas M. Shepherd dated September 30, 2004 (included in Temecula
                Valley
                Bancorp’s Form 10-K, filed on March 31, 2005, and incorporated by
                reference). #10.29
            Amended
                and Restated Salary Continuation Agreement between Temecula Valley
                Bank
                and Donald A. Pitcher entered into December 29, 2006* which exhibit
                amends
                and restates the Amended and Restated Salary Continuation Agreement
                between Donald A. Pitcher and Temecula Valley Bank dated September
                30,
                2004 (included in Temecula Valley Bancorp’s Form 10-K, filed on March 31,
                2005, and incorporated by reference). #10.30
            Amended
                and Restated Split Dollar Agreement between Temecula Valley Bank
                and
                Donald A. Pitcher entered into December 29, 2006* which exhibit amends
                and
                restates the Split Dollar Agreement between Temecula Valley Bank
                and
                Donald A. Pitcher dated September 30, 2004 (included in Temecula
                Valley
                Bancorp’s Form 10-K, filed on March 31, 2005, and incorporated 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 by reference). #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 by reference). #10.33
            Executive
                Officer Compensation disclosure (included in Temecula Valley Bancorp’s
                Form 8-K, filed on February 7, 2006, and incorporated 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 by reference).




87


10.35
            Director
                compensation disclosure filed on December 27, 2006 (included in Temecula
                Valley Bancorp's Form 8-K, filed om December 27, 2006, and incorporated
                by
                reference) revising Director Compensation disclosure originally filed
                on
                February 2, 2006 to Temecula Valley Bancorp's Form 8-K, and incorporated
                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 by reference). #10.40
            Imdemnification
                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 by reference).10.41
            Imdemnification
                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 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 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 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 by
                reference).10.45
            Executive
                Supplemental Compensation Agreement between Temecula Valley Bank
                and James
                W. Andrews entered into December 29, 2006 and incorporated by
                reference).*#10.46
            Split
                Dollar Agreement between Temecula Valley Bank and James W. Andrews
                entered
                into December 29, 2006.*#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.*#10.48
            Executive
                Supplemental Compensation Agreement between Temecula Valley Bank
                and
                Martin E. Plourd entered into December 29, 2006.*#10.49
            Split
                Dollar Agreement between Temecula Valley Bank and Martin E. Plourd
                entered
                into December 29, 2006.*#10.50
            Executive
                Supplemental Compensation Agreement between Temecula Valley Bank
                and Frank
                Basirico, Jr. entered into December 29, 2006.*#10.51
            Split
                Dollar Agreement between Temecula Valley Bank and Frank Basirico,
                Jr.
                entered into December 29, 2006.*#23.1
            Consent
                of Independent Registered Public Accountants*.23.2
            Consent
                of Independent Registered Public Accountants*.**
                Filed herewith.*
              *#
                Management contract or compensatory plan or
                arrangement*




88