**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-Q**





**x
      QUARTERLY REPORT
      PURSUANT TO SECTION 13 OR 15(d) OF**


**THE
      SECURITIES EXCHANGE ACT OF 1934**





**For
      the quarterly period ended March 31, 2007**





**OR**





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


**For
      the Transition Period from** _______ **to
      _______**





**Commission
      File No.** **0-25020**





**HERITAGE
      OAKS BANCORP**


(Exact
      name of registrant as specified in charter)





**STATE
                OF
                CALIFORNIA**
            **77-0388249**(State
                or other jurisdiction of
              incorporation
                or organization)
            (I.R.S.
                Employer Identification
                No.)


****





**545
      12th STREET, PASO ROBLES, CA 93446**


(Address
      of principal office)





**(805)
      239-5200**


(Registrant's
      telephone number, including area code)





**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 twelve (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 ninety (90) days.**





**YES
      x NO o**





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





**Large
      Accelerated filer o   Accelerated
      filer x   Non-accelerated
      filer
o**





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





**Yes
      o No x**





**Indicate
      the number of shares outstanding of each of the issuer's classes of common
      stock, as of the latest practicable date:**





**As
      of March 31, 2007 there were approximately 6,410,829 shares outstanding of
      the
      Registrant’s common stock.**




1





**TABLE
      OF CONTENTS**


Part
                  1. Financial Information
              3Item
                  1. Consolidated Financial Statements (Un-audited)
              3Consolidated
                  Balance Sheets
              4Consolidated
                  Statements of Income
              5Consolidated
                  Statements of OperationsConsolidated
                  Statement of Changes in Stockholders’ Equity
              6Consolidated
                  Statements of Comprehensive Income
              7Consolidated
                  Statements of Cash Flows
              8Notes
                  to Consolidated Financial Statements
              9Item
                  2. Management’s Discussion and Analysis ofFinancial
                  Condition and Results of
                  Operations
              16Item
                  3. Quantitative and Qualitative Disclosure about Market
                  Risk
              35Item
                  4. Controls and Procedures
              36Part
                  2. Other InformationItem
                  1. Legal Proceedings
              37Item
                  1. A. Risk Factors
              37Item
                  2. Unregistered Sales of Equity Securities and Use of
                  Proceeds
              37Item
                  3. Defaults Upon Senior Securities
              38Item
                  4. Submission of Matters to a Vote of Security Holders
              38Item
                  5. Other Information
              38Item
                  6. Exhibits
              38Signatures
              39CertificationsExhibits




2




PART
      1.
      FINANCIAL INFORMATION





**Item
      1. Financial Statements**





The
      financial statements and notes begin on next page.




3


**HERITAGE
                    OAKS BANCORP****CONSOLIDATED
                    BALANCE SHEETS***(dollars
                    amounts in thousands)*
  **March
                    31,**
                
                **December
                    31,****2007**
                
                **2006****(Unaudited)**
                
                **(1)****ASSETS**Cash
                    and due from banks
                
                $
                26,501
                
                $
                19,164Federal
                    funds sold
                
                
                8,620
                
                
                3,870Total
                    cash and cash equivalents
                
                
                35,121
                
                
                23,034Interest
                    bearing deposits with other banks
                
                
                318
                
                
                318Securities
                    available for sale
                
                
                37,620
                
                
                38,445Federal
                    Home Loan Bank Stock, at cost
                
                
                3,085
                
                
                2,350Loans
                    Held For Sale
                
                
                5,300
                
                
                1,764Loans,
                    net (2)
                
                
                460,303
                
                
                439,277Property,
                    premises and equipment, net
                
                
                14,551
                
                
                14,581Cash
                    surrender value of life insurance
                
                
                9,528
                
                
                9,435Deferred
                    tax assets
                
                
                3,218
                
                
                2,414Goodwill
                
                
                4,864
                
                
                4,865Core
                    deposit intangible
                
                
                1,059
                
                
                1,148Other
                    assets
                
                
                3,967
                
                
                4,143**TOTAL
                    ASSETS**
                
                $
                578,934
                
                $
                541,774**LIABILITIES**Deposits:Demand,
                    non-interest bearing
                
                $
                146,406
                
                $
                153,005Savings,
                    NOW, and money market deposits
                
                
                169,860
                
                
                146,110Time
                    deposits of $100 or more
                
                
                33,269
                
                
                30,630Time
                    deposits under $100
                
                
                95,476
                
                
                90,776Total
                    deposits
                
                
                445,011
                
                
                420,521FHLB
                    advances and other borrowed money
                
                
                60,000
                
                
                50,000Securities
                    sold under agreement to repurchase
                
                
                1,387
                
                
                1,364Junior
                    subordinated debentures
                
                
                16,496
                
                
                16,496Other
                    liabilities
                
                
                4,875
                
                
                3,921Total
                    liabilities
                
                
                527,769
                
                
                492,302Commitments
                    and contingencies
                
                
                -
                
                
                -**STOCKHOLDERS'
                    EQUITY**Common
                    stock, no par value;20,000,000
                    shares authorized; issued and outstanding6,410,829and 6,345,639 as of March 31, 2007and
                    December 31, 2006, respectively.
                
                
                29,802
                
                
                29,247Additional
                    paid in capital
                
                
                428
                
                
                336Retained
                    earnings
                
                
                20,809
                
                
                19,809Accumulated
                    other comprehensive income
                
                
                126
                
                
                80Total
                    stockholders' equity
                
                
                51,165
                
                
                49,472**TOTAL
                    LIABILITIES & STOCKHOLDERS' EQUITY**
                
                $
                578,934
                
                $
                541,774
  (1)
                    These numbers have been derived from the audited financial
                    statements.(2)
                    Loans net of deferred fees of $1,598 and $1,625 and allowance
                    for loan
                    loss of $4,312 and $4,081 at March 31, 2007 and December 31,
                    2006,
                    respectivelySee
                    notes to condensed consolidated financial
                    statements


4




**HERITAGE
                  OAKS BANCORP****CONSOLIDATED
                  STATEMENTS OF INCOME (UNAUDITED)***(dollar
                  amounts in thousands except per share
                  date)*


**For
                  the three months****ended
                  March 31,****2007**
              
              **2006**Interest
                  Income:Interest
                  and fees on loans
              
              $
              9,816
              
              $
              7,489Investment
                  securities
              
              
              448
              
              
              489Federal
                  funds sold and commercial paper
              
              
              31
              
              
              226Time
                  certificates of deposit
              
              
              8
              
              
              2Total
                  interest income
              
              
              10,303
              
              
              8,206Interest
                  Expense:Now
                  accounts
              
              
              28
              
              
              21MMDA
                  accounts
              
              
              667
              
              
              571Savings
                  accounts
              
              
              24
              
              
              28Time
                  deposits of $100 or more
              
              
              209
              
              
              138Other
                  time deposits
              
              
              1,212
              
              
              694Other
                  borrowed funds
              
              
              1,129
              
              
              307Total
                  interest expense
              
              
              3,269
              
              
              1,759Net
                  interest income before provision for possible loan losses
              
              
              7,034
              
              
              6,447Provision
                  for loan losses
              
              
              140
              
              
              120Net
                  interest income after provision for loan losses
              
              
              6,894
              
              
              6,327Non-Interest
                  Income:Service
                  charges on deposit accounts
              
              
              613
              
              
              568Other
                  income
              
              
              618
              
              
              650Total
                  non-interest income
              
              
              1,231
              
              
              1,218Non-Interest
                  Expense:Salaries
                  and employee benefits
              
              
              3,250
              
              
              2,783Occupancy
                  and equipment
              
              
              715
              
              
              622Other
                  expenses
              
              
              1,729
              
              
              1,579Total
                  non-interest expenses
              
              
              5,694
              
              
              4,984Income
                  before provision for income taxes
              
              
              2,431
              
              
              2,561Provision
                  for applicable income taxes
              
              
              921
              
              
              955Net
                  Income
              
              $
              1,510
              
              $
              1,606Earnings
                  per share:Basic
              
              $
              0.24
              
              $
              0.26Fully
                  Diluted
              
              $
              0.23
              
              $
              0.24
  See
                  notes to condensed consolidated financial
                  statements
  5
  **HERITAGE
                  OAKS BANCORP****CONSOLIDATED
                  STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED)****March
                  31, 2007 and March 31, 2006***(dollar
                  amounts in thousands except shares
                  outstanding)*
  **Common
                  Stock**
              
              
              
              
              
              
              
              **Accumulated****Number
                  of**
              
              
              
              **Additional****Paid-In**
              
              **Comprehensive**
              
              **Retained**
              
              **Other**
                    **Comprehensive**
              
              **Total**
                    **Stockholders'****Shares**
              
              **Amount**
              
              **Capital**
              
              **Income**
              
              **Earnings**
              
              **Income**
              
              **Equity****Balance,
                  December 31, 2006**
              
              
              6,345,639
              
              
              29,247
              
              
              336
              
              
              
              
              
              19,809
              
              
              80
              
              
              49,472Exercise
                  of stock options(including
                  $338 tax benefit from exercise of stock options)
              
              
              64,190
              
              
              555
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              555Cash
                  dividend of $0.08 per share paid on February 16, 2007
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (510
              )
              
              
              
              
              (510
              )Share-based
                  compensation expense
              
              
              
              
              
              
              
              
              92
              
              
              
              
              
              
              
              
              
              
              
              92Issuance
                  of restricted stock awards
              
              
              1,000Stock
                  repurchasedComprehensive
                  income:Net
                  income
              
              
              
              
              
              
              
              
              
              
              
              1,510
              
              
              1,510
              
              
              
              
              
              1,510Unrealized
                  security holding gains (net of $31 tax)
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              46
              
              
              46Total
                  comprehensive income
              
              
              
              
              
              
              
              
              
              
              $
              1,510**Balance,
                  March 31, 2007**
              
              
              6,410,829
              
              
              29,802
              
              
              428
              
              
              
              
              
              20,809
              
              
              126
              
              
              51,165**Balance,
                  December 31, 2005**
              
              
              6,231,982
              
              
              29,255
              
              
              -
              
              
              
              
              
              15,748
              
              
              (158
              )
              
              44,845Exercise
                  of stock options(including
                  $95 tax benefit from exercise of stock options)
              
              
              32,741
              
              
              192
              
              
              -
              
              
              
              
              
              
              
              
              
              
              
              192Share-based
                  compensation expense
              
              
              
              
              
              74
              
              
              -
              
              
              
              
              
              
              
              
              
              
              
              74Issuance
                  of restricted stock awards
              
              
              65,800
              
              
              -
              
              
              -
              
              
              
              
              
              
              
              
              
              
              
              -Comprehensive
                  income:Net
                  income
              
              
              
              
              
              
              
              
              
              
              
              1,606
              
              
              1,606
              
              
              
              
              
              1,606Unrealized
                  security holding gains (net of $8 tax)
              
              
              
              
              
              
              
              
              
              
              
              12
              
              
              
              
              
              12
              
              
              12Total
                  comprehensive income
              
              
              
              
              
              
              
              
              
              
              $
              1,618**Balance,
                  March 31, 2006**
              
              
              6,330,523
              
              
              29,521
              
              
              -
              
              
              
              
              
              17,354
              
              
              (146
              )
              
              46,729








6




**HERITAGE
                OAKS BANCORP****CONSOLIDATED
                STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)***(dollar
                amounts in thousands)*




**For
                the three months****ended
                March 31,****2007**
            
            **2006****Net
                Income**
            
            $
            1,510
            
            $
            1,606**Other
                Comprehensive Income Before Taxes:**Unrealized
                gains on securities available for sale:Unrealized
                holding gains arising during period
            
            
            77
            
            
            20Other
                comprehensive income before taxes
            
            
            77
            
            
            20Income
                tax expense related to items in comprehensive income
            
            
            (31
            )
            
            (8
            )**Other
                Comprehensive Income Net of Taxes**
            
            
            46
            
            
            12**Comprehensive
                Income**
            
            $
            1,556
            
            $
            1,618




See
                notes to condensed consolidated financial
                statements




7




**HERITAGE
                  OAKS BANCORP****CONSOLIDATED
                  STATEMENTS OF CASHFLOWS (UNAUDITED)***(dollar
                  amounts in thousands)*
  **For
                  the three month****periods
                  ended March 31,****2007**
              
              **2006****Cash
                  flows from operating activities:**Net
                  income
              
              
              1,510
              
              
              1,606Adjustments
                  to reconcile net income to net cash provided by operating
                  activities:Depreciation
                  and amortization
              
              
              265
              
              
              207Provision
                  for possible loan losses
              
              
              140
              
              
              120Amortization
                  of premiums/discounts on investment securities, net
              
              
              (21
              )
              
              2FHLB
                  stock dividends received
              
              
              (30
              )
              
              (22
              )Amortization
                  of intangible assets
              
              
              89
              
              
              75Share-based
                  compensation expense
              
              
              92
              
              
              74(Increase)/decrease
                  in loans held for sale
              
              
              (3,536
              )
              
              398Net
                  (increase) in cash surrender value of life insurance
              
              
              (93
              )
              
              (71
              )(Increase)
                  in deferred tax asset
              
              
              (835
              )
              
              -(Increase)/decrease
                  in other assets
              
              
              175
              
              
              143Excess
                  tax benefit related to share-based compensation expense
              
              
              (338
              )
              
              (95
              )Increase
                  in other liabilities
              
              
              1,292
              
              
              132**NET
                  CASH (USED IN) / PROVIDED BY OPERATING ACTIVITIES**
              
              
              (1,290
              )
              
              2,569**Cash
                  flows from investing activities:**Net
                  Change in time deposits
              
              
              -
              
              
              (20
              )Purchase
                  of available-for-sale securities
              
              
              -
              
              
              (1,190
              )Proceeds
                  from principal reductions and maturitiesof
                  available-for-sale mortgage backed securities
              
              
              923
              
              
              1,765Purchase
                  of FHLB stock
              
              
              (705
              )
              
              -Increase
                  in loans, net
              
              
              (21,257
              )
              
              (10,674
              )Allowance
                  for loan and lease loss recoveries
              
              
              92
              
              
              -Purchase
                  of property, premises and equipment, net
              
              
              (235
              )
              
              (1,357
              )**NET
                  CASH USED IN INVESTING ACTIVITIES**
              
              
              (21,182
              )
              
              (11,476
              )**Cash
                  flows from financing activities:**Increase
                  in deposits, net
              
              
              24,491
              
              
              3,922Increase
                  in FHLB borrowing
              
              
              10,000
              
              
              -Increase/(decrease)
                  in repurchase agreements
              
              
              23
              
              
              (1,893
              )Excess
                  tax benefit related to share-based compensation expense
              
              
              338
              
              
              95Proceeds
                  from exercise of stock options
              
              
              217
              
              
              97Cash
                  dividend paid
              
              
              (510
              )
              
              -**NET
                  CASH PROVIDED BY FINANCING ACTIVITIES**
              
              
              34,559
              
              
              2,221**Net
                  increase/(decrease) in cash and cash
                  equivalents**
              
              
              12,087
              
              
              (6,686
              )**Cash
                  and cash equivalents**,
                  beginning of period
              
              
              23,034
              
              
              44,559**Cash
                  and cash equivalents**,
                  end of period
              
              
              35,121
              
              
              37,873**Supplemental
                  Disclosures of Cash Flow Information**Interest
                  paid
              
              $
              3,126
              
              $
              1,715Income
                  taxes paid
              
              $
              -
              
              $
              -
  See
                  notes to condensed consolidated financial
                  statements





8





**HERITAGE
      OAKS BANCORP**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**


**MARCH
      31, 2007**





**Note
      1.**  **CONSOLIDATED FINANCIAL STATEMENTS**





The
      accompanying un-audited condensed consolidated financial statements of Heritage
      Oaks Bancorp and subsidiaries (the “Company”) have been prepared in accordance
      with the instructions to Form 10-Q and Article 10 of Regulation S-X.
      Accordingly, certain information and notes required by accounting principles
      generally accepted in the United States of America for annual financial
      statements are not included herein. In the opinion of Management, all
      adjustments (which consist solely of normal recurring accruals) considered
      necessary for a fair presentation of results for the interim periods presented
      have been included. These interim condensed consolidated financial statements
      should be read in conjunction with the financial statements and related notes
      contained in the Company’s 2006 Annual Report on Form 10-K.





The
      condensed consolidated financial statements include the accounts of the Company
      and its wholly-owned financial subsidiary, Heritage Oaks Bank (the “Bank”). All
      significant inter-company balances and transactions have been eliminated.
      Heritage Oaks Capital Trust I and Heritage Oaks Capital Trust II are
      unconsolidated subsidiaries formed solely for the purpose of issuing trust
      preferred securities. Operating results for the three months ended March 31,
      2007 are not necessarily indicative of the results that may be expected for
      the
      year ending December 31, 2007. Certain amounts in the consolidated financial
      statements for the year ended December 31, 2006 and the three month period
      ended
      March 31, 2006 may have been reclassified to conform to the presentation of
      the
      consolidated financial statements in 2007.





The
      preparation of consolidated financial statements in conformity with the
      accounting principles generally accepted in the United States of America
      requires Management to make estimates and assumptions. These estimates and
      assumptions affect the reported amounts of assets and liabilities at the date
      of
      the consolidated financial statements and the reported amounts of revenues
      and
      expenses during the reporting period. Actual results could differ from these
      estimates.





**Note
      2.**  **INVESTMENT
      SECURITIES**





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




9


The
        following table sets forth the amortized cost and fair values of investment
        securities available for sale at March 31, 2007 and December 31,
        2006:


*(dollars
                  in thousands)*
              
              
              
              **Gross**
              
              **Gross****Amortized**
              
              **Unrealized**
              
              **Unrealized**
              
              **Fair****As
                  of March 31, 2007**
              
              **Cost**
              
              **Gains**
              
              **Losses**
              
              **Value**Obligations
                  of U.S. government agencies and corporations
              
              $
              198
              
              $
              -
              
              $
              (3
              )
              $
              195Mortgage-backed
                  securities
              
              
              21,028
              
              
              15
              
              
              (301
              )
              
              20,742Obligations
                  of state and political subdivisions
              
              
              16,175
              
              
              535
              
              
              (36
              )
              
              16,674Other
                  Securities
              
              
              9
              
              
              -
              
              
              -
              
              
              9Total
              
              $
              37,410
              
              $
              550
              
              $
              (340
              )
              $
              37,620
  **Gross**
              
              
              **Gross****Amortized**
              
              
              **Unrealized**
              
              
              **Unrealized**
              
              
              **Fair****As
                  of December 31, 2006**
              
              
              **Cost**
              
              
              **Gains**
              
              
              **Losses**
              
              
              **Value**Obligations
                  of U.S. government agencies and corporations
              
              $
              205
              
              $
              -
              
              $
              (4
              )
              $
              201Mortgage-backed
                  securities
              
              
              21,959
              
              
              16
              
              
              (381
              )
              
              21,594Obligations
                  of state and political subdivisions
              
              
              16,139
              
              
              540
              
              
              (38
              )
              
              16,641Other
                  securities
              
              
              9
              
              
              -
              
              
              -
              
              
              9Total
              
              $
              38,312
              
              $
              556
              
              $
              (423
              )
              $
              38,445





**Note
      3.**  **LOANS
      AND ALLOWANCE FOR LOAN LOSSES**


**March
                  31,**
              
              **December
                  31,***(dollars
                  in thousands)*
              
              **2007**
              
              **2006**Commercial,
                  financial, and agricultural
              
              $
              91,476
              
              $
              84,976Real
                  estate-construction/land
              
              
              106,542
              
              
              105,712Real
                  estate - other
              
              
              252,080
              
              
              237,401Home
                  equity lines of credit
              
              
              9,617
              
              
              10,792Installment
                  loans to individuals
              
              
              5,705
              
              
              5,598All
                  other loans (including overdrafts)
              
              
              793
              
              
              504Total
                  loans, gross
              
              
              466,213
              
              
              444,983Less
                  - deferred loan fees, net
              
              
              (1,598
              )
              
              (1,625
              )Less
                  - reserve for possible loan losses
              
              
              (4,312
              )
              
              (4,081
              )Total
                  loans, net
              
              $
              460,303
              
              $
              439,277Loans
                  held for sale
              
              $
              5,300
              
              $
              1,764





*Concentration
      of Credit Risk*





At
      March
      31, 2007, approximately $368.2 million of the Bank’s loan portfolio was
      collateralized by various forms of real estate. Such loans are generally made
      to
      borrowers located in San Luis Obispo and Santa Barbara Counties. The Bank
      attempts to reduce its concentration of credit risk by making loans which are
      diversified by project type. While Management believes that the collateral
      presently securing this portfolio is adequate, there can be no assurances that
      significant deterioration in the California real estate market would not expose
      the Bank to significantly greater credit risk.





At
      March
      31, 2007, the Bank was contingently liable for letters of credit accommodations
      made to its customers totaling approximately $16.5 million and un-disbursed
      loan
      commitments in the approximate amount of $170 million. The Bank makes
      commitments to extend credit in the normal course of business to meet the
      financing needs of its customers. Commitments to extend credit are agreements
      to
      lend to a customer as long as there is no violation of any condition established
      in the contract. Commitments generally have fixed expiration dates or other
      termination clauses and may require payment of a fee. Since many of the
      commitments are expected to expire without being drawn upon, the total
      outstanding commitment amount does not necessarily represent future cash
      requirements. Standby letters of credit written are conditional commitments
      issued by the Bank
      to
      guarantee the performance of a customer to a third party. The credit risk
      involved in issuing letters of credit is essentially the same as those involved
      in extending loan facilities to customers.




10




*Allowance
      for Loan Losses*




An
      allowance for loan losses has been established by management to provide for
      those loans that may not be repaid in their entirety for a variety of reasons.
      The allowance is maintained at a level considered by management to be adequate
      to provide for probable incurred losses. The allowance is increased by
      provisions charged to earnings and is reduced by charge-offs, net of recoveries.
      The provision for loan losses is based upon past loan loss experience and
      management’s evaluation of the loan portfolio under current economic conditions.
      Loans are charged to the allowance for loan losses when, and to the extent,
      they
      are deemed by management to be un-collectible. The allowance for loan losses
      is
      composed of allocations for specific loans and a historical portion for all
      other loans.





An
      analysis of the changes in the reserve for possible loan losses for the periods
      indicated below is as follows:


**For
                  the three months ended**
              
              **For
                  the year ended***(dollars
                  in thousands)*
              
              **March
                  31, 2007**
              
              **March
                  31, 2006**
              
              **December
                  31, 2006**Balance
                  at beginning of period
              
              $
              4,081
              
              $
              3,881
              
              $
              3,881Additions
                  charged to operating expense
              
              
              140
              
              
              120
              
              
              600Loans
                  charged off
              
              
              (1
              )
              
              -
              
              
              (561
              )Recoveries
                  of loans previously charged off
              
              
              92
              
              
              4
              
              
              161Balance
                  at end of period
              
              $
              4,312
              
              $
              4,005
              
              $
              4,081





The
      Bank
      recognizes that credit losses will be experienced and the risk of loss will
      vary
      with, among other things, general economic conditions; the type of loan being
      made; the creditworthiness of the borrower over the term of the loan and in
      the
      case of a collateralized loan, the quality of the collateral for such loan.
      The
      allowance for loan loss represents the Bank’s estimate of the allowance
      necessary to provide for probable incurred losses in the portfolio. In making
      this determination, the Bank analyzes the ultimate ability to collect the loans
      in its portfolio by incorporating feedback provided by internal loan staff,
      an
      independent loan review function, and information provided by examinations
      performed by regulatory agencies. The Bank makes monthly evaluations as to
      the
      adequacy of the allowance for loan losses.





The
      analysis of the allowance for loan losses is comprised of three components:
      specific credit allocation; general portfolio allocation; and subjectively
      by
      determined allocation. Effective January 1, 1995, the Bank adopted SFAS No.114,
      “ *Accounting
      by Creditors for Impairment of a Loan”* (SFAS
      No. 114), as amended by SFAS No. 118, *“Accounting
      by Creditors for Impairment of a Loan - Income Recognition and
      Disclosures.”* These
      pronouncements provide that when it is probable that a creditor will be unable
      to collect all amounts due in accordance with the terms of the loan that such
      loan is deemed impaired. Impaired loans are accounted for differently in that
      the amount of the impairment is measured and reflected in the records of the
      creditor. The allowance for loan losses related to loans that are identified
      for
      evaluation in accordance with Statement No. 114 is based on discounted cash
      flows using the loan’s initial effective interest rate or the fair value of the
      collateral for certain collateral dependent loans. The general portfolio
      allocation consists of an assigned reserve percentage based on the credit rating
      of the loan. The subjective portion is determined based on loan history and
      the
      Bank’s evaluation of various factors including current economic conditions and
      trends in the portfolio including delinquencies and impairment, as well as
      changes in the composition of the portfolio.





The
      allowance for loan losses is based on estimates, and ultimate losses may 0vary
      from current estimates. These estimates are reviewed monthly, and as
      adjustments, either positive or negative, become necessary, a corresponding
      increase or decrease is made in the provision for loan losses. The methodology
      used to determine the adequacy of the allowance for possible loan losses for
      the
      three months ended March 31, 2007 is consistent with prior periods.





The
      allowance for loan losses as a percentage of total net loans was 0.94% as of
      March 31, 2007 and 0.93% as of December 31, 2006. Management believes that
      the
      allowance for loan losses at March 31, 2007 is prudent and warranted, based
      on
      information currently available.




11




**Note
      4.**  **EARNINGS
      PER SHARE**





Basic
      earnings per share are based on the weighted average number of shares
      outstanding before any dilution from common stock equivalents. Diluted earnings
      per share reflects the potential dilution that could occur if securities or
      other contracts to issue common stock were exercised or converted into common
      stock or resulted in the issuance of common stock that then share in the
      earnings of the entity.





The
      following table shows the number of shares used to calculate earnings per share
      for the three months ending


March
      31,
      2007:


**For
                    the three months ending****March
                    31,****2007**
                
                **2006**Net
                    Income
                
                $
                1,510,333
                
                $
                1,606,256Basic
                
                $
                0.24
                
                $
                0.26Diluted
                
                $
                0.23
                
                $
                0.24Shares:Basic
                
                
                6,384,150
                
                
                6,283,890Diluted
                
                
                6,605,942
                
                
                6,643,432





**Note
      5.**  **RECENT
      ACCOUNTING PRONOUNCEMENTS**





ACCOUNTING
      FOR UNCERTAINTY IN INCOME TAXES: In July 2006, the Financial Accounting
      Standards Board (FASB) issued FASB Interpretation No. 48, ” *Accounting
      for Uncertainty in Income Taxes - an interpretation of FASB Statement No.
      109”* (FIN 48)
      which clarifies the accounting and disclosure for uncertainty in tax positions,
      as defined. FIN 48 seeks to reduce the diversity in practice associated with
      certain aspects of the recognition and measurement related to accounting for
      income taxes. This interpretation is effective for fiscal years beginning after
      December 15, 2006. The Company adopted FIN 48 on January 1, 2007 and as part
      of
      the analysis of the impact of FIN 48 the company’s Chief Financial Officer and
      tax accounting firm engaged in discussions surrounding a potential disclosure
      issue related to FASB Interpretation No. 48, Accounting for *Uncertainty
      in Income Taxes—an interpretation of FASB Statement No. 109* (FIN
      48). It was concluded that a previous position taken on the Company’s 2004 and
      2005 tax returns in regard to deferred loan fees can not be supported and that
      amended returns will be filed for those periods. For income tax purposes, both
      Federal and Franchise, this is a “timing” issue and does not flow through the
      Income Statement. The Balance Sheet is impacted to the extent that current
      taxes
      payable is increased and offset by a deferred tax asset in the same
      amount.





ACCOUNTING
      FOR CERTAIN HYBRID FINANCIAL INSTRUMENTS: In February 2006, the FASB issued
      SFAS
      No. 155, "Accounting for Certain Hybrid Financial Instruments - an amendment
      of
      FASB Statements No. 133 and 140." SFAS No. 155 simplifies accounting for certain
      hybrid instruments currently governed by SFAS No. 133, "Accounting for
      Derivative Instruments and Hedging Activities," by allowing fair value
      re-measurement of hybrid instruments that contain an embedded derivative that
      otherwise would require bifurcation. SFAS No. 155 also eliminates the guidance
      in SFAS No.133 Implementation Issue No. D1, "Application of Statement 133 to
      Beneficial Interests in Securitized Financial Assets," which provides such
      beneficial interests are not subject to SFAS No.133. SFAS No. 155 amends SFAS
      No. 140, "Accounting for Transfers and Servicing of Financial Assets and
      Extinguishments of Liabilities - a Replacement of FASB Statement No. 125,"
      by
      eliminating the restriction on passive derivative instruments that a qualifying
      special-purpose entity may hold. This statement is effective for financial
      instruments acquired or issued after the beginning of the Company’s fiscal year
      2007. The adoption of this statement has not had a material impact on the
      Company’s financial condition, results of operations and cash flows.





ACCOUNTING
      FOR SERVICING OF FINANCIAL ASSETS: In March 2006, the Financial Accounting
      Standards Board (FASB) issued SFAS No. 156, "Accounting for Servicing of
      Financial Assets - an amendment of FASB Statement No. 140." SFAS No.156 requires
      an entity to recognize a servicing asset or servicing liability each time it
      undertakes an obligation to service a financial asset by entering into a
      servicing contract in specific situations. Additionally, the servicing asset
      or
      servicing liability shall be initially measured at fair value; however, an
      entity may elect the "amortization method" or "fair value method" for subsequent
      balance sheet reporting periods. SFAS No.156 is effective as of an entity's
      first fiscal year beginning after September 15, 2006. The adoption of this
      statement has not had a material impact on the Company’s statement of condition,
      results of operations and cash flows.




12


FAIR
      VALUE MEASUREMENTS: In September 2006, the FASB issued Statement of Financial
      Accounting Standards No. 157, *Fair
      Value Measurements* (SFAS
      No. 157). SFAS No. 157 enhances existing guidance for measuring assets and
      liabilities using fair value. Prior to the issuance of SFAS 157, guidance for
      applying fair value was incorporated in several accounting pronouncements.
      SFAS
      No. 157 provides a single definition of fair value, together with a framework
      for measuring it, and requires additional disclosure about the use of fair
      value
      to measure assets and liabilities. SFAS No. 157 also emphasizes that fair value
      is a market-based measurement, not an entity-specific measurement, and sets
      out
      a fair value hierarchy with the highest priority being quoted prices in active
      markets. Under SFAS No. 157, fair value measurements are disclosed by level
      within that hierarchy. While SFAS No. 157 does not add any new fair value
      measurements, it does change current practice. Changes to practice include:
      (1) a requirement for an entity to include its own credit standing in the
      measurement of its liabilities; (2) a modification of the transaction price
      presumption; (3) a prohibition on the use of block discounts when valuing
      large blocks of securities for broker-dealers and investment companies; and
      (4) a requirement to adjust the value of restricted stock for the effect of
      the restriction even if the restriction lapses within one year. SFAS No. 157
      is
      effective for financial statements issued for fiscal years beginning after
      November 15, 2007, and interim periods within those fiscal years. The
      Company has not determined the impact of adopting SFAS No. 157 on its financial
      statements.





EMPLOYERS’
      ACCOUNTING FOR DEFINED BENEFIT PENSION AND OTHER POSTRETIREMENT PLANS: In
      September 2006, the 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 132R)* (SFAS
      No.
      158), requires an employer to: (a) Recognize in its statement of financial
      position an asset for a plan’s over funded status or a liability for a plan’s
      under funded status; (b) measure a plan’s assets and its obligations that
      determine its funded status as of the end of the employer’s fiscal year (with
      limited exceptions); and (c) recognize changes in the funded status of a
      defined benefit postretirement plan in the year in which the changes occur.
      Those changes will be reported in comprehensive income of a business entity
      and
      in changes in net assets of a not-for-profit organization. The requirement
      by
      SFAS No. 158 to recognize the funded status of a benefit plan and the disclosure
      requirements of SFAS No. 158 are effective as of the end of the fiscal year
      ending after December 15, 2006 for entities with publicly traded equity
      securities. The requirement to measure plan assets and benefit obligations
      as of
      the date of the employer’s fiscal year-end statement of financial position is
      effective for fiscal years ending after December 15, 2008. The Company does
      not expect the adoption of SFAS No. 158 to have a material effect on the
      financial position of the company at March 31, 2007.





ESTABLISHING
      THE FAIR VALUE OPTION FOR FINANCIAL ASSETS AND LIABILITIES: In February of
      2007,
      the FASB Issued SFAS No. 159, *Establishing
      the Fair Value Option for Financial Assets and Liabilities.* The
      Financial Accounting Standards Board has issued SFAS 159 to permit all entities
      to choose to elect, at specified election dates, to measure eligible financial
      instruments at fair value. An entity shall report unrealized gains and losses
      on
      items for which the fair value option has been elected in earnings at each
      subsequent reporting date, and recognize upfront costs and fees related to
      those
      items in earnings as incurred and not deferred. SFAS No. 159 applies to fiscal
      years beginning after November 15, 2007, with early adoption permitted for
      an
      entity that has also elected to apply the provisions of SFAS No. 157, Fair
      Value
      Measurements. An entity is prohibited from retrospectively applying SFAS No.
      159, unless it chooses early adoption. SFAS No. 159 also applies to eligible
      items existing at November 15, 2007 (or early adoption date). The Company does
      not expect to adopt SFAS No. 159 prior to the required period and does not
      anticipate that the adoption of SFAS 159 will have a material effect on the
      Company's financial condition.





**Note
      6. SHARE-BASED COMPENSATION**





As
      of
      March 31, 2007, the Company had three share-based employee compensation plans,
      which are more fully described in Note 14 of the Consolidated Financial
      Statements in the Company's Annual Report on Form 10-K for the year ended
      December 31, 2006. These plans include two stock option plans and the 2005
      Equity Based Compensation Plan.





Effective
      January 1, 2006, the Company adopted the fair value recognition provisions
      of
      SFAS No. 123(R), using the modified prospective transition method and,
      therefore, have not restated results for prior periods.





Prior
      to
      January 1, 2006, the Company accounted for share-based compensation under the
      recognition, measurement and pro forma disclosure provisions of APB No. 25,
      the
      original provisions of SFAS No. 123, and SFAS No. 148, "Accounting for
      Stock-Based Compensation-Transition and Disclosure" (SFAS No. 148). No
      share-based compensation expense was reflected in net income as all options
      are
      required by the plan to be granted with an exercise price equal to the estimated
      fair value of the underlying common stock on the date of grant.




13




Share-based
      compensation expense for all share-based compensation awards granted after
      January 1, 2006, is based on the grant-date fair value. For all awards except
      stock option awards, the grant date fair value is either the fair market value
      per share or book value per share (corresponding to the type of stock awarded)
      as of the grant date. For stock option awards, the grant date fair value is
      estimated using the Black-Scholes option pricing model. For all awards the
      Company recognizes these compensation costs only for those shares expected
      to
      vest on a straight-line basis over the requisite service period of the award,
      for which we use the related vesting term. The Company estimates forfeiture
      rates based on historical employee option exercise and employee termination
      experience.





As
      a
      result of the Company’s January 1, 2006 adoption of SFAS No.123(R), the impact
      to the Consolidated Financial Statements on income before income taxes and
      on
      net income related to stock options expense were reductions of $28 thousand
      and
      $17 thousand, respectively for the three months ended March 31, 2007. The change
      had no significant impact on basic or diluted earnings per share for the three
      months ended March 31, 2007. During the same period last year, the Company
      reported reductions of $74 thousand in income before income taxes and $47
      thousand in net income related to the expensing of stock options. There was
      no
      impact on basic earnings per share and a $0.01 impact on diluted earnings per
      share for the period ended March 31, 2006. Additionally, prior to the adoption
      of SFAS No. 123(R), the Company presented the tax benefit of stock option
      exercises as operating cash flows, upon the adoption of SFAS No. 123(R), tax
      benefits resulting from tax deductions in excess of the compensation cost
      recognized for those options are classified as financing cash
      flows.





The
      share-based compensation expense related to stock options recognized in the
      condensed consolidated statement of operations for the three months ended March
      31, 2007 and 2006 is based on awards ultimately expected to vest, and
      accordingly has been adjusted by the amount of estimated forfeitures. SFAS
      No.
      123(R) requires forfeitures to be estimated at the time of grant and revised,
      if
      necessary, in subsequent periods if actual forfeitures differ from those
      estimates. Forfeitures were estimated based partially on historical
      experience.





The
      aggregate intrinsic value in the table below represents the total pretax
      intrinsic value for options outstanding and options exercisable as of March
      31,
      2007 and 2006 respectively. Intrinsic value is calculated by taking the
      difference between the Company’s closing stock price on the last trading day for
      the first quarters of 2007 and 2006 and the exercise price, multiplied by the
      number of in-the-money options that would have been received by the option
      holders had all option holders exercised their options on March 31, 2007 and
      2006 respectively.


**Average****Weighted**
              
              **Remaining**
              
              **Total****Average**
              
              **Contractual**
              
              **Intrinsic****Number
                  of**
              
              **Exercise**
              
              **Term**
              
              **Value****Shares**
              
              **Price**
              
              **(in
                  years)**
              
              **(in
                  000's)**Options
                  outstanding, January 1, 2007
              
              
              433,432
              
              $
              5.45Granted
              
              
              -
              
              
              -Exercised
              
              
              (64,190
              )
              
              3.39Forfeited
              
              
              (995
              )
              
              10.78Options
                  outstanding, March 31, 2007
              
              
              368,247
              
              $
              5.79
              
              
              3.78
              
              $
              4,439Exercisable
                  at March 31, 2007
              
              
              318,222
              
              $
              5.00
              
              
              3.27
              
              $
              4,088Options
                  outstanding, January 1, 2006
              
              
              525,692
              
              $
              5.19Granted
              
              
              -
              
              
              -Exercised
              
              
              (32,742
              )
              
              2.97Forfeited
              
              
              -
              
              
              -Options
                  outstanding, March 31, 2006
              
              
              492,950
              
              $
              5.33
              
              
              4.40
              
              $
              6,983Exercisable
                  at March 31, 2006
              
              
              415,616
              
              $
              4.37
              
              
              3.70
              
              $
              6,281





The
      aggregate pretax intrinsic value is subject to change based on the fair market
      value of the Company's stock. The total intrinsic value of options exercised
      for
      the three months ended March 31, 2007 and 2006 was $821 thousand and $520
      thousand respectively. The total fair value of options vested and expensed,
      net
      of tax, for the first quarter of 2007 and 2006 was $17 thousand and $47 thousand
      respectively. No options were granted during the three months ended March 31,
      2007 or in the entirety of 2006.




14


The
      total
      unrecognized compensation cost related to non-vested stock options as of March
      31, 2007 and 2006, was $198,776 and $552,804 respectively. The total remaining
      cost as of March 31, 2007 is expected to be recognized over a weighted-average
      period of 1.25 years.





The
      Company grants restricted share awards periodically for the benefit of
      employees. These restricted shares generally “cliff vest” after five years of
      issuance. Recipients of restricted shares have the right to vote all shares
      subject to such grant, and receive all dividends with respect to such shares,
      whether or not the shares have vested. Recipients do not pay any cash
      consideration for the shares. The Company records compensation expense relating
      to restricted share awards. For the three and months ended March 31, 2007 and
      2006 the Company recorded compensation expense, net of tax, of $37 thousand
      and
      $25 thousand respectively The total unrecognized compensation cost related
      to
      restricted stock awards as of March 31, 2007 and 2006, was $984,940 and
      $1,225,815 respectively. The majority of remaining compensation cost related
      to
      restricted stock awards at March 31, 2007 is expected to be recognized over
      the
      next 3.75 years.





**Note
      7.**  **RECLASSIFICATIONS**





Certain
      amounts in the 2006 financial statements have been reclassified to conform
      to
      the 2007 presentation.





**Forward
      Looking Statements**





**Certain
      statements contained in this Quarterly Report on Form 10-Q (“Quarterly Report”),
      including, without limitation, statements containing the words “believes”,
“anticipates”, “intends”, “expects”, and words of similar impact, constitute
“forward-looking statements” within the meaning of Section 27A of the Securities
      Act of 1933 and Section 21E of the Securities and Exchange Act of 1934. Such
      forward-looking statements involve known and unknown risks, uncertainties and
      other factors that may cause the actual results, performance or achievements
      of
      the Company to be materially different from any future results, performance
      or
      achievements expressed or implied by such forward-looking statements. Such
      factors include, among others, the following: general economic and business
      conditions in those areas in which the Company operates, demographic changes,
      competition, fluctuations in interest rates, changes in business strategy or
      development plans, changes in governmental regulation, credit quality, the
      availability of capital to fund the expansion of the Company’s business, as well
      as economic, political and global changes arising from the war on terrorism.
      (Refer to the Company’s December 31, 2006 10-K, ITEM 1A. Risk Factors.) The
      Company disclaims any obligation to update any such factors or to publicly
      announce the results of any revisions to any of the forward-looking statements
      contained herein to reflect future events or developments.**




15




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





The
      following is an analysis of the results of operations and financial condition
      of
      the Company for the periods ending March 31, 2007 and 2006. The analysis should
      be read in connection with the consolidated financial statements and notes
      thereto appearing elsewhere in this report.





THE
      COMPANY





Heritage
      Oaks Bancorp (the "Company") is a California corporation organized in 1994
      to
      act as a holding company of Heritage Oaks Bank ("Bank"), a 12 branch bank
      serving San Luis Obispo and northern Santa Barbara Counties. In 1994, the
      Company acquired all of the outstanding common stock of the Bank in a holding
      company formation transaction.





In
      April
      2002, the Company formed Heritage Oaks Capital Trust I (the “Trust”). The Trust
      is a statutory business trust formed under the laws of the State of Delaware.
      The Trust is a wholly-owned, non-financial, non-consolidated subsidiary of
      the
      Company.





On
      April
      23, 2007 the Company redeemed all of the Floating Rate Junior Subordinated
      Debt
      Securities it held associated with Heritage Oaks Capital Trust I. Heritage
      Oaks
      Capital Trust I was formed for the sole purpose of issuing junior subordinated
      debt securities. As a result of the redemption of all the junior subordinated
      debt securities the Company held associated with Heritage Oaks Capital Trust
      I,
      the trust is tentatively scheduled to be dissolved within the second quarter
      of
      2007.





In
      October 2006, the Company formed Heritage Oaks Capital Trust II (the “Trust”).
      The Trust is a statutory business trust formed under the laws of the State
      of
      Delaware. The Trust is a wholly-owned, non-financial, non-consolidated
      subsidiary of the Company.





Other
      than holding the shares of the Bank, the Company conducts no significant
      activities, although it is authorized, with the prior approval of the Board
      of
      Governors of the Federal Reserve System (the "Federal Reserve Board"), the
      Company's principal regulator, to engage in a variety of activities which are
      deemed closely related to the business of banking. The Company has also caused
      to be incorporated a subsidiary, CCMS Systems, Inc. which is currently inactive
      and has not been capitalized. The Company has no present plans to activate
      the
      proposed subsidiary.





*Where
      You Can Find More Information*





Under
      the
      Securities Exchange Act of 1934 Sections 13 and 15(d), periodic and current
      reports must be filed with the SEC. The Company electronically files the
      following reports with the SEC: Form 10-K (Annual Report), Form 10-Q (Quarterly
      Report), Form 8-K (Current Report), and Form DEF 14A (Proxy Statement). The
      Company may file additional forms. The SEC maintains an Internet site,
      www.sec.gov, in which all forms filed electronically may be accessed.
      Additionally, all forms filed with the SEC and additional shareholder
      information is available free of charge on the Company’s website:
      www.heritageoaksbancorp.com





The
      Company posts these reports to its website as soon as reasonably practicable
      after filing them with the SEC. None of the information on or hyperlinked from
      the Company’s website is incorporated into this Quarterly Report on Form
      10-Q.




16




**EXECUTIVE
      SUMMARY AND RECENT DEVELOPMENTS**





*Earnings
      and Financial Condition Overview*





For
      the
      three months ended March 31, 2007, the Company earned $1.5 million or $0.23
      per
      diluted share. This, when compared to the $1.6 million or $0.24 per diluted
      share the Company earned in the year ago period, represents an approximate
      6.0%
      decline. The decline in earnings is primarily attributable to higher interest
      and non-interest expenses. Interest income for the three months ended March
      31,
      2007 rose 25.6% to $10.3 million over the same period last year. The increase
      is
      mainly due to the continued strength the company has seen in its loan portfolio,
      with the balance of total gross loans increasing by $87.5 million or 23.1%
      over
      the year ago period. As mentioned, the increase in interest income was slightly
      offset by an increase in interest expense of approximately $1.5 million or
      85.8%
      over the year ago period. This has been the result of increased competition
      in
      our local markets to attract lower cost core deposits in addition to some
      customers moving deposit balances from lower interest bearing accounts to higher
      interest bearing accounts. Year-to-date, non-interest expense increased to
      $5.7
      million, compared to $5.0  million
      in the same period a year ago. At the end of 2005 the Company began a branding
      initiative which included an extensive assessment, both internally and
      externally of all bank delivery channels. Recommended actions were incorporated
      into a comprehensive Marketing Strategic Plan which is currently in process
      of
      implementation. The increase in non-interest expense has been primarily the
      result of expenses related to the branding project, the addition of staff
      including the EVP / Human Resources and EVP/ Product Delivery and full service
      branch expansion within the bank’s existing footprint in the town of Templeton.
      The Company has invested significant resources in these new initiatives
      throughout 2006 in an effort to improve our service delivery and image and
      expect to continue the investment in 2007 with the expectation of returns on
      these investments adding to shareholder value.





As
      a
      result of the increase in operating expenses, the efficiency ratio was 68.89%
      for the first quarter of 2007 compared to 65.02% for the same period in 2006.
      On
      a linked quarter basis, the efficiency ratio was 67.10% and 65.31%for the fourth
      and third quarters of 2006, respectively. The efficiency ratio measures
      non-interest expenses as a percent of revenues. Although the company’s
      efficiency ratio has risen over the last three periods, we believe the
      significant investments the Company has mentioned above are necessary to
      position the company for future growth.





As
      of
      March 31, 2007, total assets were $578.9 million. This represents a 6.9%
      increase over the prior period ended December 31, 2006. The growth in assets
      is
      mainly due to the strength in the loan portfolio, with net loans increasing
      $21.0 million or 4.8% during the first quarter. Growth in the loan portfolio
      is
      attributable to the balance of commercial real estate loans increasing by $14.7
      million or 6.2% during the first three months of 2007. Asset quality also
      remained strong with non-performing loans representing only 0.03% of total
      loans
      at March 31, 2007. The company’s limited exposure to mortgage lending has helped
      to isolate us from some of the recent problems experienced within that segment
      of the market. Total deposits also increased by $24.5 million or 5.8% over
      the
      prior period ended December 31, 2006. The growth in deposit balances is mainly
      due to a $17.2 million or 22.2% increase in money market accounts associated
      with current promotions the Company rolled out during the first quarter to
      attract lower cost core deposits. We believe these promotions will continue
      to
      help the Company obtain lower cost sources of funding as we move through the
      remainder of 2007.





*Recent
      Developments*





On
      April
      23, 2007 the Company redeemed all of the Floating Rate Junior Subordinated
      Debt
      Securities it held associated with Heritage Oaks Capital Trust I, a wholly-owned
      subsidiary of Heritage Oaks Bancorp. The redemption price was 100% of the
      principal amount redeemed plus any accrued and unpaid interest as of the
      Redemption Date. The Company paid $379,011 for the standard interest payment
      due
      April 22, 2007, plus a payment of $8,248,000 for the principal amount that
      was
      redeemed. These amounts were funded from the Company’s general corporate
      reserves. Heritage Oaks Capital Trust I was formed for the sole purpose of
      issuing junior subordinated debt securities. As a result of the redemption
      of
      all the junior subordinated debt securities the Company held associated with
      Heritage Oaks Capital Trust I, the trust is tentatively scheduled to be
      dissolved within the second quarter of 2007.





On
      April
      20, 2007 the Board of Directors declared a quarterly cash dividend of $0.08
      per
      share to be paid on May 18, 2007 to shareholders of record on May 4, 2007.





17


On
      April
      19, 2007, The Bank’s Board of Directors gave the approval for management to
      pursue the sale and lease-back of four of the bank’s properties to an
      unaffiliated party. The bank has agreed to the initial terms to sell the four
      properties and to subsequently lease them from the unaffiliated party. The
      initial terms related to this transaction provide for a forty-five (45) day
      due
      diligence period in which the unaffiliated party will perform a thorough review
      of all the terms associated with this transaction. Pending the due diligence
      period and approval of all terms and conditions by both parties, the transaction
      is tentatively scheduled to close in June of 2007.The Bank has pursued this
      transaction in an effort to convert non-earning assets to earning assets, while
      retaining the use of these properties.





On
      January 23, 2007, the Board of Directors declared a quarterly cash dividend
      of
      $0.08 per share to be paid on February 17, 2007 to shareholders of record on
      February 2, 2007.




*Selected
      Financial Data*





The
      table
      below provides selected financial data that highlights the Company’s quarterly
      performance results:


*(dollars
                  in thousands except share data)***For
                  the quarters ended****03/31/07**
              
              **12/31/06**
              
              **09/30/06**
              
              **06/30/06**
              
              **03/31/06**
              
              **12/31/05**
              
              **09/30/05**
              
              **06/30/05**Return
                  on average assets
              
              
              1.10
              %
              
              1.24
              %
              
              1.35
              %
              
              1.37
              %
              
              1.33
              %
              
              1.47
              %
              
              1.44
              %
              
              1.37
              %Return
                  on average equity
              
              
              12.10
              %
              
              13.64
              %
              
              14.54
              %
              
              14.33
              %
              
              13.92
              %
              
              16.38
              %
              
              17.03
              %
              
              15.94
              %Average
                  equity to average assets
              
              
              9.07
              %
              
              9.11
              %
              
              9.25
              %
              
              9.59
              %
              
              9.58
              %
              
              8.97
              %
              
              8.47
              %
              
              8.60
              %Net
                  interest margin
              
              
              5.66
              %
              
              5.77
              %
              
              6.07
              %
              
              6.04
              %
              
              5.98
              %
              
              6.06
              %
              
              5.80
              %
              
              5.68
              %Efficiency
                  ratio*
              
              
              68.89
              %
              
              67.12
              %
              
              65.31
              %
              
              64.34
              %
              
              65.02
              %
              
              60.65
              %
              
              61.08
              %
              
              62.66
              %Average
                  loans to average deposits
              
              
              108.23
              %
              
              105.03
              %
              
              97.15
              %
              
              94.37
              %
              
              90.15
              %
              
              89.84
              %
              
              89.60
              %
              
              91.91
              %Net
                  Income
              
              $
              1,510
              
              
              1,649
              
              $
              1,733
              
              $
              1,673
              
              $
              1,606
              
              $
              1,808
              
              $
              1,805
              
              $
              1,606Earnings
                  Per Share:Basic
              
              $
              0.24
              
              
              0.26
              
              $
              0.27
              
              $
              0.26
              
              $
              0.26
              
              $
              0.29
              
              $
              0.29
              
              $
              0.26Diluted
              
              $
              0.23
              
              
              0.25
              
              $
              0.26
              
              $
              0.25
              
              $
              0.24
              
              $
              0.27
              
              $
              0.28
              
              $
              0.25Outstanding
                  Shares:Basic
              
              
              6,384,150
              
              
              6,355,466
              
              
              6,350,727
              
              
              6,337,712
              
              
              6,283,890
              
              
              6,223,500
              
              
              6,186,045
              
              
              6,167,571Diluted
              
              
              6,605,942
              
              
              6,598,355
              
              
              6,594,626
              
              
              6,670,942
              
              
              6,643,432
              
              
              6,592,000
              
              
              6,499,178
              
              
              6,524,849





*
      The
      efficiency ratio is defined as total non-interest expense as a percent of the
      combined net interest income plus non-interest income.





The
      Company’s earnings are highly influenced by changes in short term interest
      rates. The nature of the Company’s balance sheet can be summarily described as
      of short duration and asset sensitive. The balance sheet is of short duration
      because a large percentage of its interest sensitive assets and liabilities
      re-price immediately with changes in the Federal Funds and Prime interest rates.
      The Company is asset sensitive, primarily due to its large volume of
      non-interest bearing demand deposit accounts which effectively never re-price.
      Therefore, an upward movement in short term interest rates will generally result
      in higher net interest margin and, conversely, a reduction in short term
      interest rates will result in reduced net interest margin.





Historically,
      the largest and most variable source of income for the Company is net interest
      income. The results of operations for the three months ended March 31, 2007
      and
      March 31, 2006 reflect the impact of increases in short term rates as well
      as
      growth in the volume of both interest earning assets and interest bearing
      liabilities during these periods .




*Local
      Economy*





The
      economy in the Company’s service area is based primarily on agriculture,
      tourism, light industry, oil and retail trade. Services supporting these
      industries have also developed in the areas of medical, financial and
      educational services. The population of San Luis Obispo County and the City
      of
      Santa Maria (in Northern Santa Barbara County) in 2005 **** totaled
      approximately 260,000 and 90,000, respectively, according to economic data
      provided by local county and title company sources. The moderate climate allows
      a year round growing season for numerous vegetables and fruits. Vineyards and
      cattle ranches also contribute largely to the local economy. The Central Coast’s
      leading agricultural industry is the production of high quality wine grapes
      and
      production of premium quality wines. Vineyards in production have grown
      significantly over the past several years throughout the Company’s service area.
      Access to numerous recreational activities, including lakes, mountains and
      beaches, provide a relatively stable tourist industry from many areas including
      the Los Angeles/Orange County basin, the San Francisco Bay area and the San
      Joaquin Valley. Principally due to the diversity of the various industries
      in
      the Company’s service area, the area, while not immune from economic
      fluctuations, does tend to enjoy a more stable level of economic activity than
      many other areas of California.




18




*Critical
      Accounting Policies*





The
      Company’s significant accounting policies are set forth in the 2006 Annual
      Report, Note 1 of the NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, which was
      filed on Form 10-K.





The
      following is a brief description of the Company’s current accounting policies
      involving significant management valuation judgments.





*Allowance
      for Loan and Lease Losses*





The
      Company considers its policy regarding the allowance for loan and lease losses
      to be its most critical accounting policy, because it requires management's
      most
      subjective and complex judgments. In addition, changes in economic conditions
      can have a significant impact on the allowance for loan and lease losses and
      therefore the provision for loan losses and results of operations. The Company
      has developed appropriate policies and procedures for assessing the adequacy
      of
      the allowance for loan losses, recognizing that this process requires a number
      of assumptions and estimates with respect to its loan portfolio. The Company's
      assessments may be impacted in future periods by changes in economic conditions,
      the impact of regulatory examinations, and the discovery of information with
      respect to borrowers, which is not known to management at the time of the
      issuance of the consolidated financial statements.





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





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




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





See
      Note
      3 to the Consolidated Financial Statements for further discussion on allowance
      for loan and lease losses.





*Securities
      Available for Sale*





The
      fair
      values of most securities that are designated available for sale are based
      on
      quoted market prices. If quoted market prices are not available, fair values
      are
      extrapolated from the quoted prices of similar instruments.





19





*Goodwill
      and Other Intangible Assets*





As
      discussed in the 2006 Annual Report, Note 6 of the NOTES TO CONSOLIDATED
      FINANCIAL STATEMENTS, which was filed on form 10-k, we assess goodwill and
      other
      intangible assets each year for impairment. This assessment involves estimating
      cash flows for future periods. If the future cash flows were materially less
      than the recorded goodwill and other intangible assets balances, the Company
      would be required to take a charge against earnings to write down the assets
      to
      the lower value. The Company determined that there was no impairment at December
      31, 2006.





20




**RESULTS
      OF OPERATIONS**





*Net
      Interest Income and Interest Margin*





Net
      interest income, the primary component of the net earnings of a financial
      institution, refers to the difference between the interest paid on deposits
      and
      borrowings, and the interest earned on loans and investments. The net interest
      margin is the amount of net interest income expressed as a percentage of average
      earning assets. Factors considered in the analysis of net interest income are
      the composition and volume of earning assets and interest-bearing liabilities,
      the amount of non-interest bearing liabilities and non-accrual loans, and
      changes in market interest rates.





The
      table
      below sets forth changes for the three months ended March 31, 2007 and March
      31,
      2006 the dollar difference in interest earned and paid for each major category
      of interest-earning assets and interest-bearing liabilities, and the amount
      of
      such change attributable to changes in average balances or changes in average
      rates.


**For
                  the three months ended***(dollars
                  in thousands)*
              
              **March
                  31, 2007 over 2006****Volume**
              
              **Rate**
              
              **Total****Interest
                  income:**Loans
                  (1)
              
              $
              1,916
              
              $
              411
              
              $
              2,327Investment
                  securities taxable
              
              
              (71
              )
              
              27
              
              
              (44
              )Investment
                  securities non-taxable (2):
              
              
              16
              
              
              (2
              )
              
              14Taxable
                  equivalent adjustment (2):
              
              
              (5
              )
              
              1
              
              
              (5
              )Interest-bearing
                  deposits
              
              
              -
              
              
              -
              
              
              -Federal
                  funds sold
              
              
              (243
              )
              
              48
              
              
              (195
              )Net
                  increase (decrease)
              
              
              1,612
              
              
              485
              
              
              2,097**Interest
                  expense:**Savings,
                  now, money market
              
              
              (44
              )
              
              144
              
              
              100Time
                  deposits
              
              
              380
              
              
              209
              
              
              589Other
                  borrowings
              
              
              623
              
              
              33
              
              
              656Long
                  term borrowings
              
              
              166
              
              
              (1
              )
              
              165Net
                  increase (decrease)
              
              
              1,126
              
              
              384
              
              
              1,510Total
                  net increase (decrease)
              
              $
              487
              
              $
              100
              
              $
              587


(1)
              Loan
                  fees of $288 and $350 for the three months ending March 31, 2007
                  and 2006,
                  respectively have been included in interest income
                  computation.
 (2)
                Adjusted
                    to a fully taxable equivalent basis using a tax rate of
                    34%.




21




The
      table
      below sets forth for each major category on the balance sheet the average
      balance, interest income or expense associated with each category, average
      yields and rates, and net interest income and margin for the three months ended
      March 31, 2007 and March 31, 2006. The average balance of non-accruing loans
      has
      been included in loan totals.


*(dollars
                  in thousands)*
              
              **For
                  the three months ending March 31, 2007**
              
              **For
                  the three months ending March 31, 2006****Income/**
              
              
              
              **Income/****Balance**
              
              **Rate
                  (4)**
              
              **Expense**
              
              **Balance**
              
              **Rate
                  (4)**
              
              **Expense**Interest
                  Earning Assets:Investments
                  with other banks
              
              **$**
              **318**
              
              
              **3.83**
              **%**
              **$**
              **3**
              
              **$**
              **306**
              
              
              **3.98**
              **%**
              **$**
              **3**Investment
                  securities taxable
              
              
              **24,216**
              
              
              **4.61**
              **%**
              
              **275**
              
              
              **30,200**
              
              
              **4.28**
              **%**
              
              **319**Investment
                  securities non-taxable
              
              
              **16,652**
              
              
              **4.34**
              **%**
              
              **178**
              
              
              **15,706**
              
              
              **4.36**
              **%**
              
              **169**Federal
                  funds sold
              
              
              **2,411**
              
              
              **5.21**
              **%**
              
              **31**
              
              
              **20,640**
              
              
              **4.44**
              **%**
              
              **226**Loans
                  (1) (2)
              
              
              **460,825**
              
              
              **8.64**
              **%**
              
              **9,816**
              
              
              **370,083**
              
              
              **8.21**
              **%**
              
              **7,489**Total
                  interest earning assets
              
              
              **504,422**
              
              
              **8.28**
              **%**
              
              **10,303**
              
              
              **436,935**
              
              
              **7.62**
              **%**
              
              **8,206**Allowance
                  for possible loan losses
              
              
              **(4,180**
              **)**
              
              
              
              
              
              
              
              **(3,948**
              **)**Other
                  assets
              
              
              **57,629**
              
              
              
              
              
              
              
              
              **48,802**TOTAL
                  ASSETS
              
              **$**
              **557,871**
              
              
              
              
              
              
              
              **$**
              **481,789**Interest
                  Bearing Liabilities:Savings/NOW/money
                  market
              
              
              **158,745**
              
              
              **1.84**
              **%**
              
              **720**
              
              
              **172,543**
              
              
              **1.46**
              **%**
              
              **620**Time
                  deposits
              
              
              **125,973**
              
              
              **4.57**
              **%**
              
              **1,421**
              
              
              **89,973**
              
              
              **3.75**
              **%**
              
              **832**Other
                  borrowings
              
              
              **57,241**
              
              
              **5.32**
              **%**
              
              **751**
              
              
              **12,670**
              
              
              **4.45**
              **%**
              
              **139**Federal
                  funds purchased
              
              
              **3,128**
              
              
              **5.70**
              **%**
              
              **44**
              
              
              **-**
              
              
              **-**
              
              
              **-**Long
                  Term Debt
              
              
              **16,496**
              
              
              **8.19**
              **%**
              
              **333**
              
              
              **8,248**
              
              
              **8.26**
              **%**
              
              **168**Total
                  interest-bearing liabilities
              
              
              **361,583**
              
              
              **3.67**
              **%**
              
              **3,269**
              
              
              **283,434**
              
              
              **2.52**
              **%**
              
              **1,759**Demand
                  deposits
              
              
              **141,073**
              
              
              
              
              
              
              
              
              **148,020**Other
                  liabilities
              
              
              **4,612**
              
              
              
              
              
              
              
              
              **4,201**Stockholders'
                  equityCommon
                  stock
              
              
              **29,338**
              
              
              
              
              
              
              
              
              **29,352**Additional
                  paid in capital
              
              
              **371**
              
              
              
              
              
              
              
              
              **-**Retained
                  earnings
              
              
              **20,825**
              
              
              
              
              
              
              
              
              **16,884**Valuation
                  allowance investments
              
              
              **69**
              
              
              
              
              
              
              
              
              **(102**
              **)**Total
                  stockholders' equity
              
              
              **50,603**
              
              
              
              
              
              
              
              
              **46,134**TOTAL
                  LIABILITIES AND STOCKHOLDERS' EQUITY
              
              **$**
              **557,871**
              
              
              
              
              
              
              
              **$**
              **481,789**Net
                  Interest Income
              
              
              
              
              
              
              
              **$**
              **7,034**
              
              
              
              
              
              
              
              **$**
              **6,447**Net
                  Interest Margin (3)
              
              
              
              
              
              **5.66**
              **%**
              
              
              
              
              
              
              
              **5.98**
              **%**




(1)
              Nonaccrual
                  loans have been included in total
                  loans.
 
 (2)
              Loan
                  fees of $288 and $350 for the three months ending March 31, 2007
                  and 2006,
                  respectively.
 (3)
                  Net
                      interest margin has been calculated by dividing the net interest
                      income by
                      total average earning assets.
 
 (4)
                  Annualized
                      Rate using actual number of days in
                      period.




22




The
      table
      below sets forth changes in average balances on interest earning assets and
      their respective yields for the period ended March 31, 2007 compared to the
      period ended March 31, 2006.


**Average
                  Balance for the three months ending**
              
              
              
              **Average
                  Yield for the three months ending***(dollars
                  in thousands)*
              
              **March
                  31,**
              
              **Variance**
              
              **March
                  31,**Interest
                  Earning Assets:
              
              **2007**
              
              **2006**
              
              **dollar**
              
              **percentage**
              
              **2007**
              
              **2006**
              
              **Variance**Time
                  deposits with other banks
              
              $
              318
              
              $
              306
              
              $
              12
              
              
              3.92
              %
              
              3.83
              %
              
              3.98
              %
              
              -0.15
              %Investment
                  securities taxable
              
              
              24,216
              
              
              30,200
              
              
              (5,984
              )
              
              -19.81
              %
              
              4.61
              %
              
              4.28
              %
              
              0.32
              %Investment
                  securities non-taxable
              
              
              16,652
              
              
              15,706
              
              
              946
              
              
              6.02
              %
              
              4.34
              %
              
              4.36
              %
              
              -0.03
              %Federal
                  funds sold
              
              
              2,411
              
              
              20,640
              
              
              (18,229
              )
              
              -88.32
              %
              
              5.21
              %
              
              4.44
              %
              
              0.77
              %Loans
                  (1) (2)
              
              
              460,825
              
              
              370,083
              
              
              90,742
              
              
              24.52
              %
              
              8.64
              %
              
              8.21
              %
              
              0.43
              %Total
                  interest earning assets
              
              $
              504,422
              
              $
              436,935
              
              $
              67,487
              
              
              15.45
              %
              
              8.28
              %
              
              7.62
              %
              
              0.67
              %
 
 (1)
                  Nonaccrual loans have been included in total loans.(2)
                  Loan fees of $288 and $350 for the three months ending March 31,
                  2007 and
                  2006, respectively.




The
      Company has been able to increase the loan portfolio with continued market
      penetration by a team of seasoned loan officers who are compensated for
      production. Additions to the loan portfolio for the three months ending March
      31, 2007 were achieved under the Company’s established Loan Policy.





For
      the
      three months ending March 31, 2007 compared to the same period in 2006, the
      average yield on loans improved by 43 basis points. This has been primarily
      due
      to action by the Federal Reserve Bank of raising rates by 225 basis points
      from
      June 2005 through June 2006 . See
“Item 3. Quantitative and Qualitative Disclosure about Market Risk” for further
      discussion.





The
      taxable investment portfolio gained in average yield due to extension of average
      life as the result of  rising
      rates. Taxable investment securities decreased due to regular principal
      reductions on Mortgage Backed Securities (MBS).





While
      the
      Company’s balance sheet remains asset sensitive a competitive local market has
      caused deposit costs to outpace loan yields, applying pressure on the net
      interest margin. The Company continues to remain committed to aggressively
      pursuing core deposits to provide an inexpensive source of funding to fuel
      the
      continued growth in the loan portfolio. Additionally the re-branding initiative
      is expected to contribute to the acquisition of new low cost
      deposits.





The
      table
      below sets forth changes in average balances on interest bearing liabilities
      and
      the respective rates paid for the period ended March 31, 2007 compared to the
      period ended March 31, 2006.


**Average
                  Balance for the three months ending**
              
              
              
              **Average
                  Rate for the three months ending***(dollars
                  in thousands)*
              
              **March
                  31,**
              
              **Variance**
              
              **March
                  31,**Interest
                  Bearing Liabilities:
              
              **2007**
              
              **2006**
              
              **dollar**
              
              **percentage**
              
              **2007**
              
              **2006**
              
              **Variance**Savings/NOW/money
                  market
              
              $
              158,745
              
              $
              172,543
              
              $
              (13,798
              )
              
              -8.00
              %
              
              1.84
              %
              
              1.46
              %
              
              0.38
              %Time
                  deposits
              
              
              125,973
              
              
              89,973
              
              
              36,000
              
              
              40.01
              %
              
              4.57
              %
              
              3.75
              %
              
              0.82
              %Other
                  borrowings
              
              
              57,241
              
              
              12,670
              
              
              44,571
              
              
              351.78
              %
              
              5.32
              %
              
              4.45
              %
              
              0.87
              %Federal
                  funds purchased
              
              
              3,128
              
              
              -
              
              
              3,128
              
              
              100.00
              %
              
              5.70
              %
              
              -
              
              
              5.70
              %Long
                  term debt
              
              
              16,496
              
              
              8,248
              
              
              8,248
              
              
              100.00
              %
              
              8.19
              %
              
              8.26
              %
              
              -0.07
              %Total
                  interest-bearing liabilities
              
              $
              361,583
              
              $
              283,434
              
              $
              78,149
              
              
              27.57
              %
              
              3.67
              %
              
              2.52
              %
              
              1.15
              %




For
      the
      three months ending March 31, 2007 compared to the same period in 2006, the
      Company’s average rate paid on average interest bearing liabilities increased by
      115 basis points.





23


*Non-Interest
      Income*





The
      table
      below sets forth changes in non interest income for the three months ending
      March 31, 2007 compared to the same period in 2006.


**For
                    three months ended**
                  **March
                    31,**
              
              **Variance***(dollars
                  in thousands)*
              
              **2007**
              
              **2006**
              
              **dollar**
              
              **percentage**Service
                  charges on deposit accounts
              
              $
              611
              
              $
              568
              
              $
              43
              
              
              7.6
              %ATM/Debit
                  Card Transaction/Interchange fees
              
              
              176
              
              
              175
              
              
              1
              
              
              0.6
              %Bancard
              
              
              58
              
              
              25
              
              
              33
              
              
              132.0
              %Mortgage
                  origination fees
              
              
              149
              
              
              143
              
              
              6
              
              
              4.2
              %Earnings
                  on cash surrender value life insurance
              
              
              106
              
              
              84
              
              
              22
              
              
              26.2
              %Gain
                  on sale of SBA loans
              
              
              -
              
              
              19
              
              
              (19
              )
              
              -100.0
              %Other
              
              
              131
              
              
              204
              
              
              (73
              )
              
              -35.8
              %Total
              
              $
              1,231
              
              $
              1,218
              
              $
              13
              
              
              1.1
              %




For
      the
      three months ending March 31, 2007 as compared to the same period in 2006,
      non-interest income has remained relatively unchanged. The Company has
      experienced a modest increase in service charges on deposits as well as an
      increase in Bancard revenues.





Mortgage
      Origination Fees have remained relatively unchanged compared to March 31, 2006
      seeing a slight 4.2% increase. Home sales have slowed with builders beginning
      to
      offer additional buyer incentives and lower prices. The area still remains
      desirable with prices considerably lower than the major metropolitan areas
      to
      the Company’s North and South. Reasonable mortgage rates and financing options
      such as interest only mortgages and 40 year loans have kept many in the market.
      The table below illustrates the decline in number of loans originated but an
      increase in dollar volume. Historically the first quarter of the year is one
      of
      the slowest for mortgage originations. The Company expects mortgage origination
      volume to continue to rise throughout the year as rates have begun to
      stabilize.


**For
                  the three months ended March 31,***(dollars
                  in thousands)*
              
              **2007**
              
              **2006**
              
              **Variance**Dollar
                  volume
              
              $
              15,143
              
              $
              13,708
              
              
              10.5
              %Number
                  of loans
              
              
              41
              
              
              54
              
              
              -24.1
              %





*Non-Interest
      Expenses*





The
      table
      below sets forth changes in non interest expense for the three months ending
      March 31, 2007 compared to the same period in 2006.


**For
                    three months ended****March
                  31,**
              
              **Variance***(dollars
                  in thousands)*
              
              **2007**
              
              **2006**
              
              **dollar**
              
              **percentage**Salaries
                  and employee benefits
              
              $
              3,250
              
              $
              2,783
              
              $
              467
              
              
              16.8
              %Occupany
                  and equipment
              
              
              715
              
              
              622
              
              
              93
              
              
              15.0
              %Data
                  processing
              
              
              533
              
              
              528
              
              
              5
              
              
              0.9
              %Advertising
                  and promotional
              
              
              214
              
              
              185
              
              
              29
              
              
              15.7
              %Regulatory
                  fees
              
              
              28
              
              
              29
              
              
              (1
              )
              
              -3.4
              %Other
                  professional fees and outside services
              
              
              334
              
              
              240
              
              
              94
              
              
              39.2
              %Legal
                  fees and other litigation expense
              
              
              28
              
              
              17
              
              
              11
              
              
              64.7
              %Loan
                  department costs
              
              
              42
              
              
              33
              
              
              9
              
              
              27.3
              %Stationery
                  and supplies
              
              
              94
              
              
              69
              
              
              25
              
              
              36.2
              %Director
                  fees
              
              
              74
              
              
              76
              
              
              (2
              )
              
              -2.6
              %Core
                  deposit intangible amortization
              
              
              88
              
              
              75
              
              
              13
              
              
              17.3
              %Other
              
              
              294
              
              
              327
              
              
              (33
              )
              
              -10.1
              %Total
              
              $
              5,694
              
              $
              4,984
              
              $
              710
              
              
              14.2
              %




24


Salary
      and Employee Benefits





Salaries
      and employee related expense incurred the greatest dollar increase of any
      non-interest expense category for the three months ending March 31, 2007 when
      compared to the same period in 2006. The increase was primarily a result of
      increased expenses related to the expansion of our Executive Management team
      contributing to higher officer salaries as well as additional staff to enhance
      relationship management. The addition of a full service branch within the bank’s
      existing footprint in the town of Templeton has resulted in an increase in
      salary and employee benefits as well as occupancy expenses.





Other
      Professional Fees and Outside Services





Other
      professional fees and outside services expenses increased for the quarter as
      a
      result of increases in a number of sub-categories including executive search
      expenses, consulting fees, audit fees, compliance and insurance costs. As
      competition within the primary market area has intensified, the Company has
      found it necessary to use the service of executive search firms when looking
      to
      either replace or add staff. The Company incurred additional expenses within
      this category related the appraisal of four properties that are being evaluated
      for a possible sale.





Advertising
      and Promotional





Late
      in
      2006 one of the largest community banks in our market was acquired by a major
      multi-national financial institution. The Company feels that as a result of
      this
      acquisition it presents an opportunity for us to acquire new customer
      relationships, as we are now the largest independently owned community bank
      in
      our market. The Company feels the potential to acquire new relationships, and
      in
      turn lower cost core deposits, warrants additional advertising and marketing
      efforts which are beginning to be reflected in this expense category.





Provision
      for Income Taxes





The
      provision for income taxes was 37.9% and 37.3% of net pre-tax income for the
      three months ending March 31, 2007, and 2006, respectively.





25


**FINANCIAL
      CONDITION ANALYSIS**





Total
      assets of the Company were $578.9 million at March 31, 2007 compared to $541.8
      million at December 31, 2006. This represents an increase of $37.1 million
      or
      approximately 6.8%.





*Loans*





Total
      gross loans as of March 31, 2007, increased by $21.2 million over the prior
      period ended December 31, 2006. The growth in the loan portfolio was primarily
      attributable to a $14.7 million or 6.2% increase in commercial real estate
      loan
      balances as during the first quarter of 2007.





The
      table
      below sets forth changes from December 31, 2006 to March 31, 2007 in the
      composition of the loan portfolio and provides a summary of non-performing
      assets.


*(dollars
                  in thousands)*
              
              **March
                  31,**
              
              **December
                  31,**
              
              **Variance****2007**
              
              **2006**
              
              **dollar**
              
              **percentage****Loan
                  Classifications:**Commercial,
                  financial, and agricultural
              
              $
              91,476
              
              $
              84,976
              
              $
              6,500
              
              
              7.65
              %Real
                  estate-construction/land
              
              
              106,542
              
              
              105,712
              
              
              830
              
              
              0.79
              %Real
                  estate - other
              
              
              252,080
              
              
              237,401
              
              
              14,679
              
              
              6.18
              %Home
                  equity lines of credit
              
              
              9,617
              
              
              10,792
              
              
              (1,175
              )
              
              -10.89
              %Installment
                  loans to individuals
              
              
              5,705
              
              
              5,598
              
              
              107
              
              
              1.91
              %All
                  other loans (including overdrafts)
              
              
              793
              
              
              504
              
              
              289
              
              
              57.44
              %Total
                  loans, gross
              
              
              466,213
              
              
              444,983
              
              
              21,230
              
              
              4.77
              %Less
                  - deferred loan fees, net
              
              
              1,598
              
              
              1,625
              
              
              (27
              )
              
              -1.67
              %Less
                  - reserve for possible loan losses
              
              
              4,312
              
              
              4,081
              
              
              231
              
              
              5.66
              %Total
                  loans, net
              
              $
              460,303
              
              $
              439,277
              
              $
              21,026
              
              
              4.79
              %Loans
                  held for sale
              
              $
              5,300
              
              $
              1,764
              
              $
              3,536
              
              
              200.43
              %**Asset
                  Quality:**Loans
                  delinquent 90 days or more
              
              $
              2
              
              $
              -Non-accruing
                  loans
              
              
              143
              
              
              55Total
                  non-performing loans
              
              $
              145
              
              $
              55Foreclosed
                  collateral
              
              
              -
              
              
              -Total
                  non-performing assets
              
              $
              145
              
              $
              55Ratio
                  of allowance for credit losses to total gross
              
              
              0.92
              %
              
              0.92
              %Ratio
                  of allowance for credit losses to total non-performing
                  loans
              
              
              2974
              %
              
              7420
              %Ratio
                  of non-performing loans to total gross loans
              
              
              0.03
              %
              
              0.01
              %Ratio
                  of non-performing loans to total assets
              
              
              0.03
              %
              
              0.01
              %





The
      increase in commercial, financial and agricultural loans is attributed primarily
      to a $2.5 million loan to acquire a chain of hair salons, a $1.5 million loan
      to
      a winery, a $1.2 million agricultural property loan, $1.2 million to an
      accounting firm and numerous other new $0.5 to $1.0 million business lines
      of
      credit to medical groups, contractors and others.





The
      small
      increase in real estate-construction loans can be attributed to new construction
      projects and the funding of existing construction projects. New loans include:
      a
      hotel project for $1.2 million, an addition to a strip center for $1.5 million,
      a spec residence for $1.4 million and numerous other smaller projects.
      Construction loans are typically granted for a one year period and then, with
      income properties, are amortized over not more than 30 years with 10 to 15
      year
      maturities.





The
      increase in commercial real estate loans is attributed to several of the
      construction loans moving into amortizing loans and to new commercial property
      loans. During the period, numerous loans were also refinanced and paid off
      through out of area lenders and mortgage brokers. New loans include an airport
      fuel/service facility for $4.3 million, a medical office for $1.3 million,
      an
      auto dealership for $1.5 million, a metal fabrication building for $1.0 million
      and several smaller real estate loans.




26




The
      Bank
      presently has a concentration of loans in construction/land in the amount of
      $106.4 million which represents 198% of the
      Company’s Tier I Capital. Of this, 58% are owner occupied thus the concentration
      is 140% net of owner occupied. Un-disbursed commitments total $31.7 million
      which combined with disbursed represent 257% of the Bank’s Tier I Capital with
      66% owner occupied. At March 31, 2007 there were 74 construction loans with
      outstanding balances and remaining commitments of approximately $81.4 million
      and $29.0 million, respectively. The single largest construction loan has an
      original commitment amount of approximately $12.6 million with a balance of
      approximately $7.4 million at March 31, 2007. The loan is for an office complex
      in San Luis Obispo, Ca. At March 31, 2007, there were 56 land loans with an
      aggregate balance of approximately $24.9 million. The single largest land loan
      is for a residential tract development with a commitment of $4.8 million and
      balance of $2.3 million. While these loans may be considered somewhat riskier
      than certain other real estate loans, the construction/land loans are spread
      throughout our market area and have consistently performed in a satisfactory
      manner.




Single
      family residence construction loans represent 20.3% of the total construction
      and land loan commitments. Land loans account for 20.8%, multiple family income
      properties for 9.6%, owner-occupied commercial properties for 27.7% and
      non-owner-occupied commercial properties for 21.7%. At March 31, 2007, there
      were no tract loans within this category.





Hotel
      loans disbursed are not considered to be a concentration with balances of $49.1
      million which represents 91% of the Bank’s Tier I Capital. There are several
      hotel construction loans that increase total commitments to $66.3 million which
      represents a concentration at 123% of the Bank’s Tier I Capital. At March 31,
      2007, there were 33 motel loans. The single largest loan is a construction
      loan
      for $9.2 million with $6.8 million disbursed, for luxury suite/spa facility
      located in Paso Robles, Ca. The hotel loans are also made to clients throughout
      our market. These loans have historically paid as agreed.





In
      September 2004, the Bank issued an $11.7 million irrevocable standby letter
      of
      credit to guarantee the payment of Taxable Variable Rate Demand Bonds. The
      primary purpose of the bond issue was to refinance existing debt and provide
      funds for capital improvements and expansion of an assisted living facility
      in
      San Luis Obispo. The project is 100% complete with lease up in process. The
      letter of credit will expire in September 2008.





Construction
      loan demand for both single family and commercial real estate moderated during
      the first quarter of 2007 caused primarily by an increase in interest rates
      and
      construction costs. Slowing home sales have caused some builders to begin
      offering buyer incentives, competitive mortgage rates, and creative financing
      options to help spur sales. As rates and cost of construction have risen the
      continued availability of affordable land for subdivision has allowed some
      builders to move to more rural communities within our market area in order
      to
      construct more affordable homes. Additionally, the market area continues to
      remain attractive with prices considerably lower than the major metropolitan
      areas to the Company’s North and South. Although a portion of the loan portfolio
      has seen a smaller amount of growth in the first quarter of 2007, indirectly
      related to the slow down in single family residential sales, the company
      believes, in the real estate market, that the desirability of the area and
      the
      diversity of the portfolio will provide some insulation against a significant
      slowing in growth overall in the Company’s market area.





Business
      properties are also in demand with relatively low vacancies and competitive
      loan
      rates. Commercial property values and rental rates increased during 2006. Lease
      absorption rates appear to have slowed during the first quarter of this year.
      Investors, many seeking exchange properties, continue to seek properties in
      our
      market area. Capitalization rates have steadily decreased with increased demand.
      Capitalization rate (the rate at which a stream of future cash flows is
      discounted to find their present value) ranges over the last three years are:
      6.5% to 7.5% in 2004, 5.5% to 6.5% in 2005, and 5.0% to 6.5% in 2006. Low
      capitalization rate properties typically require larger down payments in order
      to satisfy bank debt coverage requirements. The Bank has, thus far, experienced
      continued growth in commercial real estate loans this year. Interest rate
      margins are expected to decrease somewhat due to competitive pressures and
      increasing cost of funds.





27


The
      following charts give a breakdown of types of Construction/Land Loans and types
      of Commercial Real Estate loans as of March 31, 2007:




chart1 logo
            
            chart2 logo




Loans
      held for sale consist of mortgage originations that have already been sold
      pursuant to correspondent mortgage loan agreements. There is no interest rate
      risk associated with these loans as the commitments are in place at the time
      that the Bank funds them. Settlement from the correspondents is typically within
      30 to 45 days.





At
      March
      31, 2007, the Bank had no foreign loans outstanding. The Bank did not have
      any
      concentrations of loans except as disclosed above.





The
      Bank’s management is responsible for monitoring loan performance, which is done
      through various methods, including a review of loan delinquencies and personal
      knowledge of customers. Additionally, the Bank maintains both a “watch” list of
      loans that, for a variety of reasons, management believes requires regular
      review as well as an internal loan classification process. Annually, the loan
      portfolio is also reviewed by an experienced, outside loan reviewer not
      affiliated with the Bank. A list of delinquencies, the watch list, loan grades
      and the outside loan review are reviewed regularly by the Bank’s Board of
      Directors.





The
      Bank
      has a non-accrual policy that requires a loan greater than 90 days past due
      to
      be placed on non-accrual status unless such loan is well-collateralized and
      in
      the process of collection. When loans are placed on non-accrual status, all
      uncollected interest accrued is reversed from earnings. Once on non-accrual
      status, interest on a loan is only recognized on a cash basis. Loans may be
      returned to accrual status if management believes that all remaining principal
      and interest is fully collectible and there has been at least six months of
      sustained repayment performance since the loan was placed on non-accrual. At
      March 31, 2007 non-accrual loans were $143 thousand.





If
      a
      loan’s credit quality deteriorates to the point that collection of principal is
      believed by management to be doubtful and the value of collateral securing
      the
      obligation is sufficient the Bank generally takes steps to protect and liquidate
      the collateral. Any loss resulting from the difference between the loan balance
      and the fair market value of the property is recognized by a charge to the
      reserve for loan losses. When the property is held for sale after foreclosure,
      it is subject to a periodic appraisal. If the appraisal indicates that the
      property will sell for less than its recorded value, the Bank recognizes the
      loss by a charge to non-interest expense.





28


*Total
      Cash and Due from Banks*





Total
      cash and due from banks were $26.5 million  and
      $19.2
      million at March 31, 2007 and December 31, 2006, respectively. This line item
      will vary depending on cash letters from the previous night and actual cash
      on
      hand in the branches.




*Investment
      Securities and Other Earning Assets*





Other
      earning assets are comprised of Federal Home Loan Bank, Federal Funds sold
      (funds the bank lends on a short-term basis to other banks), investments in
      securities and short-term interest bearing deposits at other financial
      institutions. These assets are maintained for liquidity needs of the Bank,
      collateralization of public deposits, and diversification of the earning asset
      mix.





The
      table
      below sets forth changes from December 31, 2006 to March 31, 2007 in the
      composition of other earning assets.


**March
                  31,**
              
              **December
                  31,**
              
              **Variance***(dollars
                  in thousands)*
              
              **2007**
              
              **2006**
              
              **dollar**
              
              **percentage**Federal
                  Home Loan Bank stock
              
              $
              3,085
              
              $
              2,350
              
              $
              735
              
              
              31.28
              %Available-for-sale
                  securities
              
              
              37,620
              
              
              38,445
              
              $
              (825
              )
              
              -2.15
              %Federal
                  funds sold
              
              
              8,620
              
              
              3,870
              
              $
              4,750
              
              
              122.74
              %Interest
                  bearing deposits other financial institutions
              
              
              318
              
              
              318
              
              
              -
              
              
              0.00
              %Total
                  other earning assets
              
              $
              49,643
              
              $
              44,983
              
              $
              4,660
              
              
              10.36
              %




Investments
      available-for-sale decreased due to prepayments on Mortgage Backed Securities
      (MBS) and Collateralized Mortgage Obligations (CMO).





Fed
      funds
      sold increased 122.74% when comparing March 31, 2007 to December 31, 2006.
      The
      amount of Fed funds sold can vary widely on a daily basis depending on the
      cash
      position of the bank which is affected by numerous variables such as cash
      letters, incoming and outgoing wire activity, and loan funding
      needs.





The
      Company manages its securities portfolio to provide a source of both liquidity
      and earnings. The Bank has an asset/liability committee that develops current
      investment policies based upon its operating needs and market circumstance.
      The
      Bank’s investment policy is formally reviewed and approved annually by the board
      of directors. The asset/liability committee of the Bank is responsible for
      reporting and monitoring compliance with the investment policy. Reports are
      provided to the Bank’s boards of directors on a regular basis.





Securities
      available-for-sale are carried at fair value, with related unrealized net gains
      or losses, net of deferred income taxes, recorded as an adjustment to equity
      capital. As of December 31, 2006, net unrealized gains in the portfolio were
      $133 thousand compared to a net unrealized gain of $76 thousand at March 31,
      2007. This change in market value was driven by the slope of the yield curve
      remaining inverted with long-term 30-Year Treasury Bond rates yielding slightly
      less than the short-term 6- month T-Bill. The portfolio decreased in size due
      to
      principle reductions on MBS and CMOs.





At
      March
      31, 2007, available-for-sale securities in the portfolio included obligations
      of
      state and political subdivisions, obligations of U.S. government agencies and
      corporations and mortgage backed securities issued by various agencies.





All
      fixed
      and adjustable rate mortgage pools contain a certain amount of risk related
      to
      the uncertainty of prepayments of the underlying mortgages. Interest rate
      changes have a direct impact upon prepayment rates. The Bank uses computer
      simulation models to test the average life, duration, market volatility and
      yield volatility of adjustable rate mortgage pools under various interest rate
      assumptions to monitor volatility. Stress tests are performed quarterly.





29


*Deposits
      and Borrowed Funds*





The
      table
      below sets forth changes from December 31, 2006 to March 31, 2007 in the
      composition of deposit categories.


**%
                  of Total***(dollars
                  in thousands)*
              
              **March
                  31,**
              
              **December
                  31,**
              
              **Variance**
              
              **Deposits**Deposits:
              
              **2007**
              
              **2006**
              
              **dollar**
              
              **percentage**
              
              **3/31/07**Non-interest
                  bearing demand
              
              $
              146,406
              
              $
              153,005
              
              $
              (6,599
              )
              
              -4.31
              %
              
              32.9
              %Interest
                  bearing demand
              
              
              51,304
              
              
              45,164
              
              
              6,140
              
              
              13.59
              %
              
              11.5
              %Savings
              
              
              23,829
              
              
              23,406
              
              
              423
              
              
              1.81
              %
              
              5.4
              %Money
                  market
              
              
              94,727
              
              
              77,540
              
              
              17,187
              
              
              22.17
              %
              
              21.3
              %Time
                  deposits of $100K or more
              
              
              33,269
              
              
              30,630
              
              
              2,639
              
              
              8.62
              %
              
              7.5
              %Time
                  deposits under $100K
              
              
              95,476
              
              
              90,776
              
              
              4,700
              
              
              5.18
              %
              
              21.5
              %Total
                  deposits
              
              $
              445,011
              
              $
              420,521
              
              $
              24,490
              
              
              5.82
              %
              
              100
              %





Acquisition
      of core, low cost deposits has become the single biggest challenge facing the
      Company. Still, the Company has been able to increase deposits due to a well
      planned marketing strategy and incentive based compensation that has been in
      place for several years. Like all good strategies, this one is fluid and is
      subject to the changing dynamics within the Company’s balance sheet and staffing
      along with changes in its primary market area. A shift to higher balances in
      time deposits is the result of fierce competition for deposits driving up short
      term CD rates coupled with funding requirements for loans. Additionally, the
      rise in money market balances is in part the result of current promotions
      designed to attract additional lower cost core deposits .





At
      March
      31, 2007, non-interest bearing demand deposits provide 32.9% of total deposits
      compared to 36.4% at December 31, 2006. At March 31, 2007 and December 31,
      2006,
      the Bank had three deposit relationships that it considers to be volatile.
      These
      deposits are held by three customers of the Bank that engage in mortgage related
      activities. As a percentage of total deposits, these accounts represented 9.2%
      or $41.1 million at March 31, 2007 compared to 10.5% or $44.1 million at
      December 31, 2006. These volatile account relationships are included in the
      volatile liability dependency report that the Bank produces on a monthly basis.
      Typically, a material increase in balances held by these three customers is
      reflected in Federal Funds Sold and is recognized by Management to potentially
      be short term in nature. Therefore, any material increase in these balances
      is
      not considered to be a funding source for any form of long-term investment.
      Management and the Board of Directors of the Bank are keenly aware that as
      the
      mortgage market conditions change, these relationships will be impacted.





Core
      deposits (time deposits less than $100 thousand, demand, and savings) gathered
      in the local communities served by the Company continue to be the primary source
      of funds for loans and investments. Core deposits of $412.2 million represented
      92.6% of total deposits at March 31, 2007. The Company has the ability to
      purchase funds through deposit brokers, but has no immediate plans to do
      so.





In
      October 2005, the Company renewed a Promissory Note with Pacific Coast Bankers
      Bank (PCBB) for a revolving line of credit in the amount of $3.5 million. At
      March 31, 2007, the Company had a zero balance outstanding on this note. The
      Company pledged 646,598 shares (51%) of the Bank’s stock as collateral for the
      loan. The note is revolving in nature for the first two years. The terms of
      the
      note call for quarterly interest only payments for the first two years with
      subsequent principal and interest payments for eight years on a fully amortized
      basis. At March 31, 2007, the interest rate on the note was 8.25% and is
      variable and moves with prime. Under the terms of the agreement, the Company
      will not incur any additional debt over $2 million exclusive of inter-company
      debt and existing debt without the prior written consent of PCBB. In addition,
      the Bank must be “well” capitalized on an on-going basis as defined by bank
      regulators.





The
      Bank
      has established borrowing lines with the Federal Home Loan Bank (FHLB). At
      March
      31, 2007, the Bank had borrowings with the FHLB of $60.0 million collateralized
      by loans. The weighted average interest rate associated with these borrowings
      as
      of March 31, 2007 was 5.43%.





30


The
      table
      below sets forth the various advances the bank has obtained from the FHLB as
      of
      March 31, 2007:


*(dollars
                  in thousands)***Amount**
              
              **Interest**
              
              **Maturity****Borrowed**
              
              **Rate**
              
              **Variable/Fixed**
              
              **Date**$
              10,000
              
              
              5.50
              %
              
              Fixed
              
              
              7/25/0710,000
              
              
              5.39
              %
              
              Fixed
              
              
              5/29/0710,000
              
              
              5.53
              %
              
              Variable-
                  Daily
              
              
              Open-Ended10,000
              
              
              5.39
              %
              
              Variable-
                  Daily
              
              
              9/28/0710,000
              
              
              5.37
              %
              
              Variable-
                  Daily
              
              
              11/26/0710,000
              
              
              5.37
              %
              
              Variable-
                  Daily
              
              
              12/12/07$
              60,000
              
              
              5.43
              %




At
      maturity, Management will assess balance sheet needs and determine how much
      if
      any and at what term it will borrow from the FHLB.





On
      September 17, 2004, the Bank issued a Letter of Credit in the amount of
      approximately $11.7 million to a customer in regard to a senior care facility.
      The Letter of Credit was issued pursuant to a Letter of Credit Reimbursement
      Agreement between the Bank and the FHLB. It is collateralized by a blanket
      lien
      with the FHLB that includes all qualifying loans on the Bank’s balance sheet.





At
      March
      31, 2007, the Bank has a remaining borrowing capacity with existing collateral
      of approximately $45.5 million and $8.8 million secured by loans and securities,
      respectively.





The
      Bank
      utilizes securities sold under repurchase agreements as a source of funds.
      The
      Bank had $1.4 million in securities sold under repurchase agreements at March
      31, 2007 compared to $1.4 million at December 31, 2006.








*Capital*





The
      Company's total stockholders’ equity was $51.2 million at March 31, 2007
      compared to $49.5 million at December 31, 2006. The increase in capital was
      due
      to net income of $1.5 million, stock options exercised in the amount of $555
      thousand, the capital impact of share-based compensation expense of $92
      thousand, $510 thousand paid for a quarterly cash dividend, and an increase
      in
      accumulated other comprehensive income of $46 thousand.





Dividends





On
      April
      20, 2007 the Board of Directors declared a quarterly cash dividend of $0.08
      per
      share to be paid on May 18, 2007 to shareholders of record on May 4, 2007.





On
      January 23, 2007, the Board of Directors declared a quarterly cash dividend
      of
      $0.08 per share to be paid on February 17, 2007 to shareholders of record on
      February 2, 2007.





On
      October 20, 2006, the Board of Directors declared a quarterly cash dividend
      of
      $0.08 per share to be paid on November 17, 2006 to shareholders of record on
      November 3, 2006





On
      July
      21, 2006, the Board of Directors declared a quarterly cash dividend of $0.08
      per
      share to be paid on August 25, 2006 to shareholders of record on August 11,
      2006.





On
      April
      21, 2006 the Company declared a $0.25 per share special cash dividend to be
      paid
      on May 19, 2006 to shareholders of record on May 8, 2006. The special dividend
      was declared in lieu of recent annual stock dividends the Company has declared.





31


Stock
      Repurchases





On
      July
      21, 2006, the Board of Directors adopted a resolution authorizing the repurchase
      of up to 40,000 shares of the Company’s common stock. Purchases are to be made,
      as conditions warrant, from time to time in the open market. The duration of
      the
      program is one year and the timing of purchases will depend on market
      conditions.





On
      October 20, 2006, the Board of Directors adopted a resolution to increase the
      number of shares available for repurchase to 100,000 for the repurchase plan
      that was adopted in July 2006.





Trust
      Preferred Securities





On
      April
      10, 2002, the Company issued $8,248,000 of Floating Rate Junior Subordinated
      Deferrable Interest Debentures (the “debt securities”) to Heritage Oaks Capital
      Trust I, a statutory trust created under the laws of the State of Delaware.
      These debt securities are subordinated to effectively all borrowings of the
      Company and are due and payable on April 22, 2032. Interest is payable
      semi-annually on these debt securities at 6-Month LIBOR plus 3.7% for an
      effective rate of 9.09% as of March 31, 2007. The debt securities can be called
      at any time commencing on April 22, 2007, at par. The debt securities can also
      be redeemed at par if certain events occur that impact the tax treatment,
      regulatory treatment or the capital treatment of the issuance. The Company
      also
      purchased a 3% minority interest totaling $248 thousand in Heritage Oaks Capital
      Trust I. The balance of the equity of Heritage Oaks Capital Trust I is comprised
      of mandatorily redeemable preferred securities and is included in other assets.
      The Company used the proceeds from the sale of the securities for general
      corporate purposes, including the repayment of outstanding indebtedness of
      $1.9
      million on April 11, 2002 and capital contributions to the Bank for future
      growth.





On
      April
      23, 2007 the Company redeemed all of the Floating Rate Junior Subordinated
      Debt
      Securities it held associated with Heritage Oaks Capital Trust I, a wholly-owned
      subsidiary of Heritage Oaks Bancorp. The redemption price was 100% of the
      principal amount redeemed plus any accrued and unpaid interest as of the
      Redemption Date. The Company paid $379,011 for the standard interest payment
      due
      April 22, 2007, plus a payment of $8,248,000 for the principal amount that
      was
      redeemed on that date. These amounts were funded from the Company’s general
      corporate reserves. Heritage Oaks Capital Trust I was formed for the sole
      purpose of issuing junior subordinated debt securities. As a result of the
      redemption of all the junior subordinated debt securities the Company held
      associated with Heritage Oaks Capital Trust I, the trust is tentatively
      scheduled to be dissolved within the second quarter of 2007.





On
      October 27, 2006, the Company issued $8,248,000 of Floating Rate Junior
      Subordinated Deferrable Interest Debentures (the “debt securities”) to Heritage
      Oaks Capital Trust II, a statutory trust created under the laws of the State
      of
      Delaware. These debt securities are subordinated to effectively all borrowings
      of the Company and are due and payable on October 27, 2036. Interest is payable
      quarterly on these debt securities at 3-Month LIBOR plus 1.71% for an effective
      rate of 7.08% as of March 31, 2007. The debt securities can be called at any
      time commencing on October 27, 2011, at par. The debt securities can also be
      redeemed at par if certain events occur that impact the tax treatment or the
      capital treatment of the issuance. The Company also purchased a 3% minority
      interest totaling $248,000 in Heritage Oaks Capital Trust II. The balance of
      the
      equity of Heritage Oaks Capital Trust II is comprised of mandatory redeemable
      preferred securities and is included in other assets.





The
      Company intends to use the proceeds of the sale of the Trust Preferred
      Securities issued to Heritage Oaks Capital Trust II for general corporate
      purposes which may include investment in the Bank, acquisitions, investments,
      payment of dividends and repurchases of our outstanding common stock.





Under
      FASB Interpretation (FIN) No. 46, “Consolidation of Variable Interest Entities,
      an interpretation of ARB No. 51,” the Company is not allowed to consolidate
      Heritage Oaks Capital Trust I and II into the Company’s financial statements.
      Prior to the issuance of FIN No. 46, Bank holding companies typically
      consolidated these entities. On February 28, 2005, the Federal Reserve Board
      issued a new rule which provides that, notwithstanding the deconsolidation
      of
      such trusts, junior subordinated debentures, such as those issued by the
      Company, may continue to constitute up to 25% of a bank holding company's Tier
      1
      capital, subject to certain new limitations which will not become effective
      until March 31, 2009 and which, in any event, are not expected to affect the
      treatment of the Company's Junior Subordinated Debentures as Tier 1 capital
      for
      regulatory purposes. As of March 31, 2007, the Company has included $14.9
      million of the net junior subordinated debt associated with both Heritage Oaks
      Capital Trust I and Heritage Oaks Capital Trust II in its Tier1 Capital for
      regulatory capital purposes.”





If
      the
      Company elects to defer interest payments pursuant to terms of the agreement,
      then the Company may not (i) declare or pay any dividends or distributions
      on,
      or redeem, purchase, acquire or make a liquidation payment with respect to
      any
      of the Company’s capital stock, or (ii) make any payment of principal of or
      premium, if any, or interest on or repay, repurchase or redeem any debt
      securities of the Company that rank pari passu with or junior in interest to
      the
      Debt Securities, other than, among
      other items, a dividend in the form of stock, warrants, options or other rights
      in the same stock as that on which the dividend is being paid or ranks pari
      passu with or junior to such stock. The prohibition on payment of dividends
      and
      payments on pari passu or junior debt also applies in the case of an event
      of
      default under the agreements.




32




At
      March
      31, 2007, the Company had sufficient cash to service the existing $16.5 million
      in junior subordinated debenture interest payments for approximately six years
      without dividends from subsidiaries. The Bank’s capacity to provide cash to the
      Company, while remaining “well-capitalized”, was $5.8 million at March 31,
      2007 .





Regulatory
      Capital Requirements





Capital
      ratios for commercial banks in the United States are generally calculated using
      three different formulas. These calculations are referred to as the “Leverage
      Ratio” and two “risk-based” calculations known as: “Tier One Risk Based Capital
      Ratio” and the “Total Risk Based Capital Ratio.” These standards were developed
      through joint efforts of banking authorities from 12 different countries around
      the world. The standards essentially take into account that different types
      of
      assets have different levels of risk associated with them. Furthermore, they
      take into account the off-balance sheet exposures of banks when assessing
      capital adequacy.





The
      Leverage Ratio calculation simply divides common stockholders’ equity (reduced
      by any goodwill a bank may have) by the total assets. In the Tier One Risk
      Based
      Capital Ratio, the numerator is the same as the leverage ratio, but the
      denominator is the total “risk-weighted assets”. Risk weighted assets are
      determined by segregating all the assets and off balance sheet exposures into
      different risk categories and weighting them by a percentage ranging from 0%
      (lowest risk) to 100% (highest risk). The Total Risk Based Capital Ratio again
      uses “risk-weighted assets” in the denominator, but expands the numerator to
      include other capital items besides equity such as a limited amount of the
      loan
      loss reserve, long-term capital debt, preferred stock and other instruments.





Summarized
      below are the Company’s and the Bank’s capital ratios at March 31, 2007.


**Regulatory
                  Standard**
              
              **Heritage**
              
              **Heritage****Adequately**
              
              **Well**
              
              **Oaks**
              
              **Oaks****Capitalized**
              
              **Capitalized**
              
              **Bancorp**
              
              **Bank**Leverage
                  Ratio
              
              
              4.00
              %
              
              5.00
              %
              
              10.87
              %
              
              9.77
              %Tier
                  I Risk Based Captial Ratio
              
              
              4.00
              %
              
              6.00
              %
              
              11.42
              %
              
              10.26
              %Total
                  Risk Based Captial Ratio
              
              
              8.00
              %
              
              10.00
              %
              
              12.28
              %
              
              11.11
              %




*Liquidity*





The
      objective of liquidity management is to ensure the continuous availability
      of
      funds to meet the demands of depositors, investors and borrowers. Asset
      liquidity is primarily derived from loan payments and the maturity of other
      earning assets. Liquidity from liabilities is obtained primarily from the
      receipt of new deposits. The Bank’s Asset Liability Committee (ALCO) is
      responsible for managing the on and off-balance sheet commitments to meet the
      needs of customers while achieving the Bank’s financial objectives. ALCO meets
      regularly to assess the projected funding requirements by reviewing historical
      funding patterns, current and forecasted economic conditions and individual
      customer funding needs. Deposits generated from Bank customers serve as the
      primary source of liquidity. The Bank has credit arrangements with correspondent
      banks that serve as a secondary liquidity source in the amount of $13.5 million.
      As of March 31, 2007, the Bank had no borrowings against credit arrangements
      with these correspondent banks . The Bank
      is a member of the FHLB and has a collateralized borrowing capacity remaining
      of
      approximately $54 million.





The
      Bank
      manages liquidity by maintaining a majority of the investment portfolio in
      federal funds sold and other liquid investments. At March 31, 2007, the ratio of
      liquid assets not pledged for collateral and other purposes to deposits and
      other liabilities was 11.93% compared to 9.31% at December 31, 2006. The ratio
      of net loans to deposits (LTD), another key liquidity ratio, was 103.4% at
      March
      31, 2007 compared to 104.5% at December 31, 2006 both of which remain within
      the
      Bank’s policy guidelines. While the Bank still provides the majority of loan
      funding with core deposits, due to the highly competitive nature of deposit
      gathering the Bank has found it necessary to rely on borrowed funds. With the
      banking industry’s common use of alternative funding sources, i.e. FHLB
      borrowing, in 2006 the Bank implemented a tracking ratio of Loan-to-Funding
      (LTF). This ratio is calculated by dividing gross loans by the sum of total
      deposits and alternative funding sources both available and used. At March
      31,
      2007 the LTF ratio was 81.75% compared to 82.93% at December 31, 2006 both
      of
      which remain within the Bank’s policy guidelines as well. The Bank’s key focus
      remains to increase core deposits and minimize alternative funding sources.




33


*Inflation*





The
      assets and liabilities of a financial institution are primarily monetary in
      nature. As such they represent obligations to pay or receive fixed and
      determinable amounts of money that are not affected by future changes in prices.
      Generally, the impact of inflation on a financial institution is reflected
      by
      fluctuations in interest rates, the ability of customers to repay debt and
      upward pressure on operating expenses. The effect of inflation over the past
      four-year period has been significant to the Company’s financial position and
      results of operations in regard to fluctuation in interest rates creating in
      the
      decreasing rate environment a narrowing of the net interest margin and in the
      increasing rate environment for the past two years, a widening of the net
      interest margin. Rates have recently begun to level off and the Company’s net
      interest margin has seen a small amount of contraction over the past quarter
      narrowing by 11 basis points. There has been a great deal of news in the
      national media related to the rising rate environment leading to the inability
      of some borrowers in the single family residential sub-prime and alt- a markets
      to repay their debt. However, the Company’s primary focus is commercial lending
      and the strong underwriting requirements of the Company has continued to lend
      itself to outstanding asset quality as evidenced by a 0.03% non-performing
      loan
      to total net loan ratio as of March 31, 2007.





*Off-Balance
      Sheet Arrangements*





Off-balance
      sheet arrangements are any contractual arrangement to which an unconsolidated
      entity is a party, under which the Company has: (1) any obligation under a
      guarantee contract; (2) a retained or contingent interest in assets transferred
      to an unconsolidated entity or similar arrangement that serves as credit,
      liquidity or market risk support to that entity for such assets; (3) any
      obligation under certain derivative instruments; or (4) any obligation under
      a
      material variable interest held by the Company in an unconsolidated entity
      that
      provides financing, liquidity, market risk or credit risk support to the
      Company, or engages in leasing, hedging or research and development services
      with the Company.





In
      the
      ordinary course of business, the Company has entered into off-balance sheet
      financial instruments consisting of commitments to extend credit, commercial
      letter of credit, and standby letter of credit. Such financial instruments
      are
      recorded in the financial statement when they are funded or related fees are
      incurred or received. For a fuller discussion of these financial instruments,
      refer to Note 10 of the Company’s consolidated financial statements contained in
      Item 8 of Part II of the Company’s December 31, 2006 10-K.





In
      the
      ordinary course of business, the Bank is a party to various operating leases.
      For a fuller discussion of these financial instruments, refer to Note 5 of
      the
      Company’s consolidated financial statements contained in Item 8 of Part II of
      the Company’s December 31, 2006 10-K.





In
      connection with the $16.5 million in debt securities discussed in “ *Capital* ,”
the
      Company issued the full and unconditional payment guarantee of certain accrued
      distributions.





34






**Item
      3.**  **Quantitative
      and Qualitative Disclosure about Market Risk**





As
      a
      financial institution, the Company’s primary component of market risk is
      interest rate volatility. Fluctuations in interest rates will ultimately impact
      both the level of interest income and interest expense recorded on a large
      portion of the Company’s assets and liabilities, and the market value of all
      interest earning assets and interest bearing liabilities, other than those
      which
      possess a short term to maturity. Virtually all of the Company’s interest
      earning assets and interest bearing liabilities are located at the banking
      subsidiary level. Thus, virtually all of the Company’s interest rate risk
      exposure lies at the banking subsidiary level other than $16.5 million, as
      of
      March 31, 2007, in subordinated debentures issued by the Company’s subsidiary
      grantor trusts. As a result, all significant interest rate risk procedures
      are
      performed at the banking subsidiary level. The subsidiary bank’s real estate
      loan portfolio, concentrated primarily within Northern Santa Barbara County
      and
      San Luis Obispo County, California, are subject to risks associated with the
      local economy.





The
      fundamental objective of the Company’s management of its assets and liabilities
      is to maximize the Company’s economic value while maintaining adequate liquidity
      and an exposure to interest rate risk deemed by Management to be acceptable.
      Management believes an acceptable degree of exposure to interest rate risk
      results from the management of assets and liabilities through maturities,
      pricing and mix to attempt to neutralize the potential impact of changes in
      market interest rates. The Company’s profitability is dependent to a large
      extent upon its net interest income, which is the difference between its
      interest income on interest-earning assets, such as loans and investments,
      and
      its interest expense on interest-bearing liabilities, such as deposits and
      borrowings. The Company is subject to interest rate risk to the degree that
      its
      interest-earning assets re-price differently than its interest-bearing
      liabilities. The Company manages its mix of assets and liabilities with the
      goals of limiting its exposure to interest rate risk, ensuring adequate
      liquidity, and coordinating its sources and uses of funds.




The
      Company seeks to control interest rate risk exposure in a manner that will
      allow
      for adequate levels of earnings and capital over a range of possible interest
      rate environments. The Company has adopted formal policies and practices to
      monitor and manage interest rate risk exposure.  Management believes
      historically it has effectively managed the effect of changes in interest rates
      on its operating results.  Management believes that it can continue to
      manage the short-term effect of interest rate changes under various interest
      rate scenarios.




Management
      employs the use of an Asset and Liability Management software that is used
      to
      measure the Bank’s exposure to future changes in interest rates. This model
      measures the expected cash flows and re-pricing of each financial
      asset/liability separately in measuring the Bank’s interest sensitivity. Based
      on the results of this model, management believes the Bank’s balance
      sheet is “asset sensitive”. This means the Company expects (all other
      things being equal) to expand its net interest income if rates rise and expects
      it conversely to contract if rates fall.  The level of potential or
      expected contraction indicated by the tables below is considered acceptable
      by
      management and is compliant with the Bank’s ALCO policies.  Management will
      continue to perform this analysis each quarter to further validate the expected
      results against actual data.




The
      hypothetical impacts of sudden interest rate movements applied to the Company’s
      asset and liability balances are modeled monthly. The results of this movement
      indicate how much of the Company’s net interest income is “at risk” from various
      rate changes over a one year horizon. This exercise is valuable in identifying
      risk exposures. Management believes the results for the Company’s March 31, 2007
      balances indicate that the net interest income at risk over a one year time
      horizon for a 1% and 2% rate increase and decrease is acceptable at this
      time.


**Shock
                  Rate Scenarios***(dollars
                  in thousands)*
              
              **-200bp**
              
              **-100bp**
              
              **Base**
              
              **+100bp**
              
              **+200bp**Net
                  interest income (NII)
              
              $
              25,192
              
              $
              26,121
              
              $
              27,194
              
              $
              28,100
              
              $
              29,012$
                  Change from base
              
              $
              (2,002
              )
              $
              (1,073
              )
              $
              -
              
              $
              906
              
              $
              1,817%
                  Change from base
              
              
              -7.36
              %
              
              -3.95
              %
              
              0.00
              %
              
              3.33
              %
              
              6.68
              %


It
      is
      important to note that the above table is a summary of several forecasts and
      actual results may vary. The forecasts are based on estimates and assumptions
      of
      management that may turn out to be different and may change over time. Factors
      affecting these estimates and assumptions include, but are not limited to 1)
      competitor behavior, 2) economic conditions both locally and nationally, 3)
      actions taken by the Federal Reserve Board, 4) customer behavior and 5)
      management’s responses. Changes that vary significantly from the assumptions and
      estimates may have significant effects on the Company’s net interest income;
      therefore, the results of this analysis should not be relied upon as indicative
      of actual future results.





35


The
      following tables show Management’s estimates of how the loan portfolio is broken
      out between variable-daily, variable at various time lines, fixed rate loans
      and
      estimates of re-pricing opportunities for the entire loan portfolio.




*(dollars
                  in thousands)***Total
                  Gross Loans**
              
              **Percent
                  of****Rate
                  Type**
              
              **Balance**
              
              **Total**Variable
                  - daily
              
              $
              191,495
              
              
              41
              %Variable
                  other than daily
              
              
              203,881
              
              
              44
              %Fixed
                  rate
              
              
              70,837
              
              
              15
              %Total
                  gross loans
              
              $
              466,213
              
              
              100
              %


The
      table
      above identifies approximately 41% of the loan portfolio that will re-price
      immediately in a changing rate environment.




*(dollars
                  in thousands)***Total
                  Gross Loans**
              
              **Percent
                  of****Re-Pricing**
              
              **Balance**
              
              **Total**<
                  1 Year
              
              $
              267,541
              
              
              57
              %1-3
                  Years
              
              
              116,352
              
              
              25
              %3-5
                  Years
              
              
              51,893
              
              
              11
              %>
                  5 Years
              
              
              30,428
              
              
              7
              %Total
                  gross loans
              
              $
              466,213
              
              
              100
              %




**Item
      4.**  **Controls
      and Procedures**





*Evaluation
      of Disclosure Controls and Procedures*





As
      of the
      end of the period covered by this report, the Company carried out an evaluation,
      under the supervision and with the participation of its management, including
      the Company’s Chief Executive Officer and Chief Financial Officer, of the
      effectiveness of the design and operation of the Company’s disclosure controls
      and procedures pursuant to Exchange Act Rules 13a-15 and 15d-15. Based upon
      that
      evaluation, the Chief Executive Officer and Chief Financial Officer concluded
      that the Company’s disclosure controls and procedures are effective to provide
      reasonable assurances that information required to be disclosed in the reports
      the Company files or submits under the Securities Exchange Act of 1934 is
      recorded, processed, summarized and reported within the time periods specified
      in the SEC’s rules and forms.





There
      was
      no change in the Company’s internal controls over financial reporting during the
      quarter ended March 31, 2007 that has materially affected, or is reasonably
      likely to materially affect, the Company’s internal controls over financial
      reporting.





In
      designing and evaluating disclosure controls and procedures, the Company’s
      management recognized that any controls and procedures, no matter how well
      designed and operated, can provide only reasonable, not absolute, assurances
      of
      achieving the desired control objectives and management necessarily was required
      to apply its judgment in evaluating the cost-benefit relationship of possible
      controls and procedures.





36


PART
      2.
      OTHER INFORMATION





**Item
      1.**  **Legal
      Proceedings**





The
      Company is not a party to any material legal proceeding.




**Item
      1A.Risk Factors**





During
      the period covered by this report there were no material changes from risk
      factors as previously disclosed in the Company’s December 31, 2006 10k in
      response to Item A to Part I of Form 10k.




**Item
      2.**  **Changes
      in Securities, Use of Proceeds and Issuer Purchases of Equity
      Securities**





*Unregistered
      Sale of Equity Securities*





None.




*Purchases
      of Equity Securities*





On
      July
      21, 2006, the Board of Directors adopted a one year stock repurchase plan in
      the
      initial amount of 40,000 shares. In October 2006, the Board of Directors adopted
      a resolution to increase the total number of shares available for repurchase
      under the plan to 100,000.





As
      of
      December 31, 2006, the Company had repurchased 40,000 shares of its common
      stock
      under the repurchase plan at an average market price of $17.95 per share. As
      of
      March 31, 2007, there were 60,000 shares of common stock available for purchase
      under the repurchase plan. During the three months ending March 31, 2007, the
      company made no additional purchases of its common stock under the repurchase
      plan.





The
      table
      below summarizes our Quarterly repurchases of our common equity
      securities:




**Period**
                
                **Total
                    number of shares purchased**
                
                **Average
                    price paid per share**
                
                **Total
                    number of shares that may yet be purchased under the publicly
                    announced
                    plan**Q3
                    2006
                
                
                15,000
                
                $
                16.56
                
                
                25,000Q4
                    2006 (1)
                
                
                25,000
                
                $
                18.79
                
                
                60,000Q1
                    2007
                
                
                -
                
                
                -
                
                
                60,000Total
                
                
                40,000
                
                $
                17.95
                
                
                60,000


(1)
        Includes the additional 60,000 shares added to the plan in October
        2006
  37


**Item
      3.**  **Defaults
      Upon Senior Securities**





N/A





**Item
      4.**  **Submission
      of Matters to a Vote of Security Holders**





N/A





**Item
      5.**  **Other
      Information**





N/A





**Item
      6.**  **Exhibits**





(a)
      Exhibits :





Exhibit
      (31.1)  Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act
      of
      2002





Exhibit
      (31.2)  Certification
      of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act
      of
      2002





Exhibit
      (32.1)  Certification
      of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act
      of
      2002





Exhibit
      (32.2)  Certification
      of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act
      of
      2002





38




**SIGNATURES**





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





HERITAGE
      OAKS BANCORP





DATE:
      May
      9, 2007








/s/
      Lawrence P. Ward


Lawrence
      P. Ward


President


Chief
      Executive Officer







/s/
      Margaret A. Torres


Margaret
      A. Torres


Executive
      Vice President


Chief
      Financial Officer


(Principal
      Financial and Accounting Officer)





39