**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, 2006**





**[
      ] 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**  ****


**(State
      or other jurisdiction of incorporation or organization)**


**77-0388249**


**(I.R.S.
      Employer Identification Code)**





**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
      ____**





**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 [ ] Accelerated filer [ ] Non-accelerated filer
      [x]**





**Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Act). Yes [ ] 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 April 28, 2006 there were approximately 6,331,273 shares outstanding of
      the
      Registrant’s common stock.**














**TABLE
        OF CONTENTS**
 
 Part
          1.
          Financial Information
 
 Item
          1.
          Consolidated Financial Statements (Unaudited)
 
 Consolidated
          Balance Sheets
 Consolidated
          Statements of Operations
 Consolidated
          Statement of Changes in Stockholders’ Equity
 Consolidated
          Statements of Cash Flows
 Notes
          to
          Consolidated Financial Statements
 
 Item
          2.  Management’s
          Discussion and Analysis of
 Financial
          Condition and Results of Operations
 
 Item
          3.  Quantitative
          and Qualitative Disclosure about Market Risk
 
 Item
          4.  Controls
          and Procedures
 
 Part
          2.
          Other Information
 
 Item
          1.  Legal
          Proceedings
 Item
          1A.
          Risk Factors
 Item
          2.  Unregistered
          Sales of Equity Securities and Use of Proceeds
 Item
          3.  Defaults
          Upon Senior Securities
 Item
          4.  Submission
          of Matters to a Vote of Security Holders
 Item
          5.  Other
          Information
 Item
          6.  Exhibits
 
 Signatures
 
 Certifications
 
 Exhibits


-2-





PART
      1.
      FINANCIAL INFORMATION


Item
      1.
      Financial Statements





**HERITAGE
                OAKS BANCORP****CONSOLIDATED
                BALANCE SHEETS****(in
                thousands)**
            
            **March
                31,**
            
            **December
                31,****2006**
            
            **2005****ASSETS**
            
            **(Un-audited)**
            
            **(1)**Cash
                and due from banks
            
            $
            17,398
            
            $
            18,279Federal
                funds sold
            
            
            20,475
            
            
            26,280Total
                cash and cash equivalents
            
            
            37,873
            
            
            44,559Interest
                bearing deposits other banks
            
            
            318
            
            
            298Securities
                Available for sale
            
            
            43,847
            
            
            44,402Federal
                Home Loan Bank Stock, at cost
            
            
            1,907
            
            
            1,885Loans
                Held For Sale
            
            
            2,994
            
            
            3,392Loans,
                net
            
            
            373,189
            
            
            362,635Property,
                premises and equipment, net
            
            
            13,055
            
            
            11,905Cash
                surrender value life insurance
            
            
            7,777
            
            
            7,706Deferred
                Tax Assets
            
            
            2,352
            
            
            2,358Goodwill
            
            
            4,865
            
            
            4,865Core
                Deposit Intangible
            
            
            1,373
            
            
            1,448Other
                assets
            
            
            2,901
            
            
            3,048**TOTAL
                ASSETS**
            
            **$**
            **492,451**
            
            **$**
            **488,501****LIABILITIES**Deposits:Demand,
                non-interest bearing
            
            $
            156,406
            
            $
            164,014Savings,
                NOW, and money market deposits
            
            
            173,421
            
            
            170,106Time
                deposits of $100 or more
            
            
            17,229
            
            
            17,414Time
                deposits under $100
            
            
            74,663
            
            
            66,263Total
                deposits
            
            
            421,719
            
            
            417,797FHLB
                advances and other borrowed money
            
            
            10,000
            
            
            10,000Securities
                Sold under Agreement to Repurchase
            
            
            1,954
            
            
            3,847Junior
                subordinated debentures
            
            
            8,248
            
            
            8,248Other
                liabilities
            
            
            3,801
            
            
            3,764Total
                liabilities
            
            
            445,722
            
            
            443,656**STOCKHOLDERS'
                EQUITY**Common
                stock, no par value;20,000,000
                shares authorized; issued and outstanding6,330,523
                and 6,231,982 for March 31, 2006and
                December 31, 2005, respectively.
            
            
            29,521
            
            
            29,255Retained
                earnings
            
            
            17,354
            
            
            15,748Accumulated
                other comprehensive income
            
            
            (146
            )
            
            (158
            )Total
                stockholders' equity
            
            
            46,729
            
            
            44,845**TOTAL
                LIABILITIES & STOCKHOLDERS' EQUITY**
            
            **$**
            **492,451**
            
            **$**
            **488,501**(1)
                These numbers have been derived from the audited financial
                statements.See
                notes to consolidated financial statements





-3-





**HERITAGE
                OAKS BANCORP****CONSOLIDATED
                STATEMENTS OF INCOME**




**For
                the Three Months Ended****(in
                thousands except per share date)**
            
            **March
                31,****2006**
            
            **2005****(Unaudited)**
            
            **(Unaudited)**Interest
                Income:Interest
                and fees on loans
            
            $
            7,489
            
            $
            6,122Investment
                securities
            
            
            489
            
            
            553Federal
                funds sold and commercial paper
            
            
            226
            
            
            70Time
                certificates of deposit
            
            
            2
            
            
            3Total
                interest income
            
            
            8,206
            
            
            6,748Interest
                Expense:Now
                accounts
            
            
            21
            
            
            21MMDA
                accounts
            
            
            571
            
            
            213Savings
                accounts
            
            
            28
            
            
            17Time
                deposits of $100 or more
            
            
            138
            
            
            82Other
                time deposits
            
            
            694
            
            
            231Other
                borrowed funds
            
            
            307
            
            
            421Total
                Interest Expense
            
            
            1,759
            
            
            985Net
                interest income before provision for possible loan losses
            
            
            6,447
            
            
            5,763Provision
                for loan losses
            
            
            120
            
            
            180Net
                interest income after provision for loan losses
            
            
            6,327
            
            
            5,583Non-interest
                Income:Service
                charges on deposit accounts
            
            
            568
            
            
            539Other
                income
            
            
            650
            
            
            593Total
                Non-interest Income
            
            
            1,218
            
            
            1,132Non-interest
                Expense:Salaries
                and employee benefits
            
            
            2,783
            
            
            2,248Occupancy
                and equipment
            
            
            622
            
            
            612Other
                expenses
            
            
            1,579
            
            
            1,563Total
                Noninterest Expenses
            
            
            4,984
            
            
            4,423Income
                before provision for income taxes
            
            
            2,561
            
            
            2,292Provision
                for applicable income taxes
            
            
            955
            
            
            875**Net
                Income**
            
            **$**
            **1,606**
            
            **$**
            **1,417**Earnings
                per share: See Note #4**Basic**
            
            **$**
            **0.26**
            
            **$**
            **0.23****Fully
                Diluted**
            
            **$**
            **0.24**
            
            **$**
            **0.22**See
                notes to consolidated financial statements














-4-








**HERITAGE
                OAKS BANCORP****CONSOLIDATED
                STATEMENTS OF COMPREHENSIVE INCOME****(Unaudited,
                in thousands)****Three
                Month Period****Ended
                March 31,****2006**
            
            **2005****Net
                Income**
            
            **$**
            **1,606**
            
            **$**
            **1,417****Other
                Comprehensive Income Before Taxes:**Unrealized
                gains (losses) on securities available for sale:Unrealized
                holding gains (losses) arising during period
            
            
            20
            
            
            (554
            )Reclassification
                adjustments for (gains) included in net income
            
            
            -
            
            
            -Other
                comprehensive income (loss), before taxes
            
            
            20
            
            
            (554
            )Income
                tax expense (credit) related to items in comprehensive
                income
            
            
            (8
            )
            
            221**Other
                Comprehensive Income (Loss), Net of Taxes**
            
            
            12
            
            
            (333
            )**Comprehensive
                Income**
            
            **$**
            **1,618**
            
            **$**
            **1,084**




See
                notes to consolidated financial statements




















-5-








**HERITAGE
                OAKS BANCORP****CONSOLIDATED
                STATEMENTS OF STOCKHOLDERS' EQUITY****March
                31, 2006 and March 31, 2005****(Unaudited)****(
                in thousands except shares outstanding)**




**Accumulated****Other**
            
            **Total****Shares**
            
            **Common**
            
            **Retained**
            
            **Comprehensive**
            
            **Stockholders'****Outstanding**
            
            **Stock**
            
            **Earnings**
            
            **Income/(Loss)**
            
            **Equity****Balance
                January 1, 2006**
            
            
            6,231,982
            
            $
            29,255
            
            $
            15,748
            
            $
            (158
            )
            $
            44,845Exercise
                of Stock Options
            
            
            32,741
            
            
            192
            
            
            -
            
            
            
            
            
            192(including
                $95 tax benefit from exerciseof
                stock options)Stock
                options expense
            
            
            
            
            
            74
            
            
            
            
            
            
            
            
            74Issuance
                of Restricted Stock Awards
            
            
            65,800
            
            
            -
            
            
            
            
            
            
            
            
            -Comprehensive
                IncomeNet
                Income
            
            
            
            
            
            
            
            
            1,606
            
            
            
            
            
            1,606Unrealized
                Security Holding Gains (net of $8 tax )
            
            
            
            
            
            
            
            
            
            
            
            12
            
            
            12Total
                other comprehensive Income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,618**Balance
                March 31, 2006**
            
            
            **6,330,523**
            
            **$**
            **29,521**
            
            **$**
            **17,354**
            
            **$**
            **(146**
            **)**
            **$**
            **46,729**




**Accumulated****Other**
            
            
            **Total****Shares**
            
            
            **Common**
            
            
            **Retained**
            
            
            **Comprehensive**
            
            
            **Stockholders'****Outstanding**
            
            
            **Stock**
            
            
            **Earnings**
            
            
            **Income/(Loss)**
            
            
            **Equity****Balance
                January 1, 2005**
            
            
            3,817,943
            
            $
            24,050
            
            $
            13,053
            
            $
            147
            
            $
            37,250Exercise
                of Stock Options
            
            
            89,664
            
            
            365
            
            
            -
            
            
            
            
            
            3655%
                Stock Dividend distributed April 22, 2005
            
            
            195,380
            
            
            3,937
            
            
            (3,937
            )Comprehensive
                IncomeNet
                Income
            
            
            
            
            
            
            
            
            1,417
            
            
            
            
            
            1,417Unrealized
                Security Holding Gains (net of $222 tax )
            
            
            
            
            
            
            
            (333
            )
            
            (333
            )Total
                other comprehensive Income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,084**Balance
                March 31, 2005**
            
            
            **4,102,987**
            
            **$**
            **28,352**
            
            **$**
            **10,533**
            
            **$**
            **(186**
            **)**
            **$**
            **38,699**See
                notes to consolidated financial statements





-6-





**HERITAGE
                OAKS BANCORP****CONSOLIDATED
                STATEMENTS OF CASHFLOWS**




**(in
                thousands)**
            
            **Periods
                ended March 31,****2006**
            
            **2005****(Unaudited)**
            
            **(Unaudited)****Cash
                Flows from Operating Activities**Net
                income
            
            $
            1,606
            
            $
            1,417Adjustments
                to reconcile net income tonet
                cash provided by operating activitiesNet
                cash provided by operating activitiesDepreciation
                and amortization
            
            
            207
            
            
            229Provision
                for possible loan losses
            
            
            120
            
            
            180Amortization
                of premiums/discounts oninvestment
                securities, net
            
            
            2
            
            
            72Amortization
                of intangible assets
            
            
            75
            
            
            143(Increase)/decrease
                in loans held for sale
            
            
            398
            
            
            (3,288
            )Net
                change in FHLB and FRB stock
            
            
            (22
            )
            
            -Stock
                options expense
            
            
            74
            
            
            -Net
                increase in cash surrender value of life insurance
            
            
            (71
            )
            
            (61
            )Decrease
                in other assets
            
            
            143
            
            
            216Increase
                in other liabilities
            
            
            37
            
            
            644**NET
                CASH PROVIDED BY/(USED IN) OPERATING ACTIVITIES**
            
            
            **2,569**
            
            
            **(448**
            **)****Cash
                Flows From Investing Activities**Purchase
                of time deposits
            
            
            (20
            )
            
            -Purchase
                of securities available-for-sale
            
            
            (1,190
            )
            
            -Proceeds
                from principal reductions and maturitiesof
                mortgage backed securities available-for-sale
            
            
            1,765
            
            
            3,670Purchase
                of life insurance policies
            
            
            -
            
            
            (300
            )Increase
                in loans, net
            
            
            (10,674
            )
            
            (2,909
            )Purchase
                of property, premises and equipment, net
            
            
            (1,357
            )
            
            (258
            )**NET
                CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES**
            
            
            **(11,476**
            **)**
            
            **203****Cash
                Flows From Financing Activities**Increase
                in deposits, net
            
            
            3,922
            
            
            22,000Net
                decrease in other borrowings
            
            
            (1,893
            )
            
            (34
            )Proceeds
                from exercise of stock options
            
            
            97
            
            
            365Tax
                benefit related to stock options
            
            
            95
            
            
            -**NET
                CASH PROVIDED BY FINANCING ACTIVITIES**
            
            
            **2,221**
            
            
            **22,331****Net
                Increase/(Decrease) in Cash and Cash Equivalents**
            
            
            (6,686
            )
            
            22,086**Cash
                and Cash Equivalents**,
                Beginning of year
            
            
            44,559
            
            
            21,867**Cash
                and Cash Equivalents**,
                End of period
            
            **$**
            **37,873**
            
            **$**
            **43,953****Supplemental
                Disclosures of Cash Flow Information**Interest
                paid
            
            $
            1,715
            
            $
            627See
                notes to consolidated financial statements








-7-


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





The
      accompanying unaudited 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 2005 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 is an unconsolidated subsidiary formed solely
      for
      the purpose of issuing trust preferred securities. Operating results for the
      three months ended March 31, 2006 are not necessarily indicative of the results
      that may be expected for the year ending December 31, 2006. Certain amounts
      in
      the consolidated financial statements for the year ended December 31, 2005
      and
      the three month period ended March 31, 2005 may have been reclassified to
      conform to the presentation of the consolidated financial statement in
      2006.





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.




-8-





The
                amortized cost and fair values of investment securities available
                for sale
                at March 31, 2006 andDecember
                31, 2005 :**March
                31, 2006**
            
            
            
            **Gross**
            
            **Gross****(in
                thousands)**
            
            **Amortized**
            
            **Unrealized**
            
            **Unrealized**
            
            **Fair****Cost**
            
            **Gains**
            
            **Losses**
            
            **Value**Obligations
                of U.S. government agencies and corporations
            
            $
            824
            
            $
            -
            
            $
            (15
            )
            $
            809Mortgage-backed
                securities
            
            
            26,993
            
            
            15
            
            
            (590
            )
            
            26,418Obligations
                of State and Political Subdivisions
            
            
            16,264
            
            
            428
            
            
            (81
            )
            
            16,611Other
                Securities
            
            
            9
            
            
            -
            
            
            -
            
            
            9**TOTAL**
            
            **$**
            **44,090**
            
            **$**
            **443**
            
            **$**
            **(686**
            **)**
            **$**
            **43,847****December
                31, 2005**
            
            
            
            
            
            **Gross**
            
            
            **Gross****(in
                thousands)**
            
            
            **Amortized**
            
            
            **Unrealized**
            
            
            **Unrealized**
            
            
            **Fair****Cost**
            
            
            
            
            
            **Gains**
            
            
            **Losses**
            
            
            **Value**Obligations
                of U.S. government agencies and corporations
            
            $
            826
            
            $
            -
            
            $
            (20
            )
            $
            806Mortgage-backed
                securities
            
            
            28,795
            
            
            13
            
            
            (518
            )
            
            28,290Obligations
                of State and Political Subdivisions
            
            
            15,036
            
            
            364
            
            
            (103
            )
            
            15,297Other
                Securities
            
            
            9
            
            
            -
            
            
            -
            
            
            9**TOTAL**
            
            **$**
            **44,666**
            
            **$**
            **377**
            
            **$**
            **(641**
            **)**
            **$**
            **44,402**





Note
      3.  LOANS
      AND
      ALLOWANCE FOR LOAN LOSSES





Major
                classifications of loans were:**March
                31,**
            
            **December
                31,****(in
                thousands)**
            
            **2006**
            
            **2005**Commercial,
                financial, and agricultural
            
            $
            65,079
            
            $
            60,050Real
                estate-construction
            
            
            86,533
            
            
            76,981Real
                estate - other
            
            
            208,271
            
            
            210,690Home
                equity lines of credit
            
            
            13,168
            
            
            14,398Installment
                loans to individuals
            
            
            5,418
            
            
            5,620All
                other loans (including overdrafts)
            
            
            251
            
            
            394378,720
            
            
            368,133Less
                - deferred loan fees, net
            
            
            (1,526
            )
            
            (1,617
            )Less
                - reserve for possible loan losses
            
            
            (4,005
            )
            
            (3,881
            )Total
                loans
            
            
            373,189
            
            
            362,635Loans
                Held For Sale
            
            $
            2,994
            
            $
            3,392





Concentration
      of Credit Risk





At
      March
      31, 2006, approximately $308.0 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.


-9-





At
      March
      31, 2006, the Bank was contingently liable for letters of credit accommodations
      made to customers totaling approximately $16.7 million and un-disbursed loan
      commitments in the approximate amount of $139.8 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. The Bank anticipates
      no losses as a result of such transactions.





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 is
                as
                follows:**(in
                thousands)**
            
            **March
                31,**
            
            **December
                31,****2006**
            
            **2005**Balance
                at beginning of year
            
            $
            3,881
            
            $
            3,247Additions
                charged to operating expense
            
            
            120
            
            
            710Loans
                charged off
            
            
            0
            
            
            (100
            )Recoveries
                of loans previously charged off
            
            
            4
            
            
            24Balance
                at end of year
            
            $
            4,005
            
            $
            3,881





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 collectability of 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 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 credit losses related to loans
      that are identified for evaluation in accordance with Statement 114 is based
      on
      discounted cash flows using the loan’s initial effect 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.


-10-





The
      allowance for loan losses is based on estimates, and ultimate losses will vary
      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
      first quarter of 2006 is consistent with prior periods.





The
      allowance for loan losses as a percentage of total net loans was 1.07% as of
      March 31, 2006 and 1.07% as of December 31, 2005. Management believes that
      the
      allowance for credit losses at March 31, 2006 is prudent and warranted, based
      on
      information currently available.





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 shares in the
      earnings of the entity.





On
      March
      25, 2005, the Company’s Board of Directors declared a 5% stock dividend. The
      record date for the stock dividend was April 8, 2005 and the pay date was April
      22, 2005. In addition, on October 21, 2005, the Board of Directors declared
      a
      50% stock split payable on December 2, 2005 to stockholders of record on
      November 10, 2005. Share information has been retroactively adjusted for the
      stock split and dividend.





The
      following table shows the number of shares used to calculate and the earnings
      per share for the three months ending March 31, 2006 and 2005:








**For
                the Three Months Ending****March
                31,**
            
            **March
                31,****2006**
            
            **2005**Net
                Income
            
            $
            1,606,256
            
            $
            1,417,386Basic
            
            $
            0.26
            
            $
            0.23Diluted
            
            $
            0.24
            
            $
            0.22Shares:Basic
            
            
            6,283,890
            
            
            6,080,850Diluted
            
            
            6,643,432
            
            
            6,458,433





Note
      5.  RECENT
      ACCOUNTING PRONOUNCEMENTS





SHARE-BASED
      PAYMENT: Effective January 1, 2006, we adopted the fair value recognition
      provisions of statement of Financial Accounting Standards (SFAS) No. 123
      (revised 2004), "Share-Based Payment" (SFAS No.123(R)), using the modified
      prospective transition method and, therefore, have not restated results for
      prior periods. Under this transition method, stock-based compensation expense
      for the first quarter of 2006 included compensation expense for all stock-based
      compensation awards granted prior to, but not yet vested as of January 1, 2006,
      based on the grant date fair value estimated in accordance with the original
      provision of SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS
      No.123"). Stock-based compensation expense for all stock-based compensation
      awards granted after January 1, 2006 is based on the grant-date fair value
      estimated in accordance with the provisions of SFAS No.123(R). The Company
      recognizes these compensation costs on a straight-line basis over the requisite
      service period of the award. Prior to the January 1, 2006 adoption of SFAS
      No.123(R), the Company recognized stock-based compensation expense in accordance
      with Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock
      Issued to Employees" (APB No. 25). In March 2005, the Securities and Exchange
      Commission (the SEC) issued Staff Accounting Bulletin No. 107 (SAB No. 107)
      regarding the SEC's interpretation of SFAS No.123(R) and the valuation of
      share-based payments for public companies. The Company has applied the
      provisions of SAB No. 107 in its adoption of SFAS No. 123(R). See Note 6 to
      the
      Unaudited Consolidated Financial Statements for a further discussion on
      stock-based compensation.


-11-





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. Early adoption is
      permitted as of the beginning of an entity's fiscal year, provided the entity
      has not yet issued financial statements, including interim financial statements,
      for any period of that fiscal year. The Company does not expect the adoption
      of
      this statement to have a material impact on its financial condition, results
      of
      operations or cash flows.





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
      remeasurement 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. We do not expect the adoption of this statement to have a material impact
      on the Company’s financial condition, results of operations or cash
      flows.





MEANING
      OF OTHER-THAN-TEMPORARY IMPAIRMENT: In November 2005, the Financial Accounting
      Standards Board (FASB) issued Staff Position (FSP) SFAS No. 115-1 and 124-1,
      "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain
      Investments." The FSP addresses the determination of when an investment is
      considered impaired, whether that impairment is other-than-temporary, and the
      measurement of an impairment loss. The FSP also includes accounting
      considerations subsequent to the recognition of an other-than-temporary
      impairment and requires certain disclosures about unrealized losses that have
      not been recognized as other-than-temporary impairments. The FSP amends SFAS
      No.
      115, "Accounting for Certain Investments in Debt and Equity Securities," and
      SFAS No. 124, "Accounting for Certain Investments Held by Not-for-Profit
      Organizations," and APB Opinion No. 18, "The Equity Method of Accounting for
      Investments in Common Stock." The FSP nullifies certain requirements of EITF
      Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and its
      Application to Certain Investments," and supersedes Emerging Issues Task Force
      (EITF) Abstracts, Topic D-44, "Recognition of Other-Than-Temporary Impairment
      upon the Planned Sale of a Security Whose Cost Exceeds Fair Value." The FSP
      was
      required to be applied to reporting periods beginning after December 15, 2005.
      The issuance of this FSP did not have a material impact on the financial
      condition, the results of operations, or liquidity of the Company.





ACCOUNTING
      CHANGES AND ERROR CORRECTIONS: In May 2005, the FASB issued SFAS No. 154,
      "Accounting for Changes and Error Corrections," which changes the accounting
      for
      and reporting of a change in accounting principle. This statement also applies
      to all voluntary changes in accounting principle and changes required by an
      accounting pronouncement in the unusual instance that the pronouncement does
      not
      include specific transition provisions. This statement requires retrospective
      application to prior period financial statements of changes in accounting
      principle, unless it is impractical to determine either the period - specific
      or
      cumulative effects of the change. SFAS No. 154 was effective for accounting
      changes made in fiscal years beginning after December 15, 2005. The adoption
      of
      this standard did not have a material effect on the financial condition, the
      results of operations or liquidity of the Company.





Note
      6.
      Stock-Based Compensation





As
      of
      March 31, 2006, we had three stock-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, 2005.
      These
      plans include two stock option plans and the 2005 Equity Based Compensation
      Plan.


-12-





Effective
      January 1, 2006, we 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. Under this transition method,
      stock-based compensation expense for the first quarter of 2006 included
      compensation expense for all stock-based compensation awards granted prior
      to,
      but that remained unvested as of, January 1, 2006. Compensation expense was
      based on the grant date fair value estimated in accordance with the original
      provision of SFAS No. 123.





Prior
      to
      January 1, 2006, the Company accounted for stock-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 148





Stock-based
      compensation expense for all stock-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 for the three months ended March 31,
      2006 on income before income taxes and on net income were reductions of $74
      thousand and $47 thousand, respectively. The cumulative effect of the change
      in
      accounting was $74 thousand before income taxes and $47 thousand, after income
      taxes. The change had no impact on basic earnings per share for the three months
      ended March 31, 2006 and had a $0.01 per share impact on diluted earnings per
      share for the same period. In addition, 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.





PRO
      FORMA
      INFORMATION UNDER SFAS NO. 123





Pro
      forma
      information regarding the effect on the net income and basic and diluted income
      per share for the three months ended March 31, 2005, had the Company applied
      the
      fair value recognition provisions of SFAS No. 123, are as
      follows:


-13-





**For
                Three Months Ended****March
                31, 2005**Net
                income, as reported (000's)
            
            
            
            
            $
            1,417Add:
                Stock-based employee compensation costincluded
                in reported net income, net of relatedtax
                effects
            
            
            
            
            
            -Deduct:
                Total stock-based employee compensationcost
                determined under fair value based methodfor
                all awards, net of related tax effects
            
            (48
            )Pro
                forma net income
            
            
            
            
            
            1,369Earnings
                per share:Basic--as
                reported
            
            
            
            
            $
            0.23Basic--pro
                forma
            
            
            
            
            $
            0.23Diluted--as
                reported
            
            
            
            
            $
            0.22Diluted--pro
                forma
            
            
            
            
            $
            0.21








The
      stock-based compensation expense recognized in the condensed consolidated
      statement of operations for the three months ended March 31, 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 (the difference between the Company’s closing stock price on the
      last trading day of the first quarter of 2006 (March 31, 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, 2006, this amount changes based on the fair market value of the
      Company's stock. Total intrinsic value of options exercised for the three months
      ended March 31, 2006 was $520 thousand. Total fair value of options vested
      and
      expensed was $47 thousand, net of tax, for the three months ended March 31,
      2006. No options were granted during the three months ended March 31, 2006
      or
      2005.


**Average****Weighted**
            
            **Remaining**
            
            **Total****Average**
            
            **Contractual**
            
            **Intrinsic****Number
                of**
            
            **Exercise**
            
            **Term**
            
            **Value****Shares**
            
            **Price**
            
            **(in
                years)**
            
            **(in
                000's)**Options
                outstanding, beginning of quarter
            
            
            525,692
            
            $
            5.19Granted
            
            
            -
            
            
            -Exercised
            
            
            (32,742
            )
            
            2.9691Forfeited
            
            
            -
            
            
            -Options
                outstanding, end of quarter
            
            
            492,950
            
            $
            5.33
            
            
            4.4
            
            $
            6,983Vested
                and expected to vest at March 31, 2006
            
            
            492,950
            
            $
            5.33
            
            
            4.4
            
            $
            6,983Exercisable
                at March 31, 2006
            
            
            415,616
            
            $
            4.37
            
            
            3.7
            
            $
            6,281




As
      of
      March 31, 2006, there was $522,804 of total unrecognized compensation cost
      related to nonvested share-based compensation arrangements. That cost is
      expected to be recognized over a weighted-average period of 4.4
      years.


-14-





The
      following table summarizes information about stock options outstanding at March
      31, 2006:





**Weighted****Average**
            
            **Weighted**
            
            
            
            **Weighted****Range
                of**
            
            **Number**
            
            **Remaining**
            
            **Average**
            
            **Number**
            
            **Average****Exercise**
            
            **of
                shares**
            
            **Contractual**
            
            **Exercise**
            
            **of
                shares**
            
            **Exercise****Prices**
            
            **Outstanding**
            
            **Life**
            
            **Price**
            
            **Exercisable**
            
            **Price**$2.55
                to $5.74
            
            361,558
            
            3.21
            
            $3.70
            
            361,558
            
            $3.70$5.80
                to $10.27
            
            41,892
            
            6.18
            
            6.91
            
            24,774
            
            6.67$10.79
                to $13.84
            
            89,500
            
            7.95
            
            11.22
            
            29,284
            
            11.02**Totals**
            
            **492,950**
            
            **4.32**
            
            **5.33**
            
            **415,616**
            
            **4.39**








The
      fair
      value of each stock option was estimated on the date of grant using the
      Black-Scholes option-pricing model with the weighed average assumptions included
      on the table above, under the header "Stock Based Option Valuation and Expense
      Information under SFAS No.123(R)".





Note
      7.  Reclassifications





Certain
      amounts in the 2005 financial statements have been reclassified to conform
      to
      the 2006 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, 2005 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, 2006 and 2005. 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"), an 11 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
      October 31, 2003, the Company acquired Hacienda Bank and on June 28, 2004,
      Hacienda Bank was merged with and into the Bank.





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





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.





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





SELECTED
                FINANCIAL DATAFor
                the Quarter Ended,Mar-06
            
            Dec-05
            
            Sep-05
            
            Jun-05
            
            Mar-05
            
            Dec-04Return
                on Average Assets
            
            
            1.33
            %
            
            1.47
            %
            
            1.44
            %
            
            1.37
            %
            
            1.24
            %
            
            1.18
            %Return
                on Average Equity
            
            
            13.92
            %
            
            16.38
            %
            
            17.03
            %
            
            15.94
            %
            
            14.74
            %
            
            14.77
            %Average
                Equity to Average Assets
            
            
            9.58
            %
            
            8.97
            %
            
            8.47
            %
            
            8.60
            %
            
            8.40
            %
            
            6.76
            %Net
                Interest Margin
            
            
            5.90
            %
            
            6.06
            %
            
            5.80
            %
            
            5.68
            %
            
            5.55
            %
            
            5.40
            %Efficiency
                Ratio*
            
            
            65.02
            %
            
            60.65
            %
            
            61.08
            %
            
            62.66
            %
            
            64.14
            %
            
            67.64
            %Average
                Loans to Average Deposits
            
            
            90.15
            %
            
            89.84
            %
            
            89.60
            %
            
            91.91
            %
            
            92.82
            %
            
            85.65
            %Net
                Income
            
            $
            1,606
            
            $
            1,808
            
            $
            1,805
            
            $
            1,606
            
            $
            1,417
            
            $
            1,353Earnings
                Per Share:Basic
            
            $
            0.26
            
            $
            0.29
            
            $
            0.29
            
            $
            0.26
            
            $
            0.23
            
            $
            0.23Diluted
            
            $
            0.24
            
            $
            0.27
            
            $
            0.28
            
            $
            0.25
            
            $
            0.22
            
            $
            0.21Outstanding
                Shares:Basic
            
            
            6,283,890
            
            
            6,223,500
            
            
            6,186,045
            
            
            6,167,571
            
            
            6,080,805
            
            
            6,010,964Diluted
            
            
            6,643,432
            
            
            6,592,000
            
            
            6,499,178
            
            
            6,524,849
            
            
            6,458,433
            
            
            6,460,174







*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
      reprice 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 reprice.
      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, 2006
      and
      March 31, 2005 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





-17-


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.





Critical
      Accounting Policies





The
      Company’s significant accounting policies are set forth in the 2005 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





Changes
      in economic conditions can have a significant impact on the allowance for loan
      losses and therefore the provision for loan losses and results of operations.
      The Company has developed 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 the Company 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 a further discussion on Allowance
      for Loan Losses.





Securities
      Available for Sale





The
      fair
      value 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.





-18-


Goodwill
      and Other Intangible Assets





As
      discussed in the 2005 Annual Report, Note 6 of the NOTES TO CONSOLIDATED
      FINANCIAL STATEMENTS, 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,
      2005.





RESULTS
      OF OPERATIONS





Earnings
      Overview





The
      Company reported net income for the three months ended March 31, 2006 of $1.6
      million compared to $1.4 million during the same period in 2005. This represents
      an increase of 13%. Basic earnings per share for the three months ended March
      31, 2006 and March 31, 2005, were $0.26 and $0.23, respectively. Diluted
      earnings per share for the three months ended March 31, 2006 and March 31,
      2005,
      were $0.24 and $0.22, respectively. The earnings increase for 2006 was primarily
      attributable to a favorable interest rate environment, increases in and changes
      to the mix of average earning assets as well as an increase in non-interest
      bearing demand deposits.





As
      compared to the fourth quarter of 2005 the Company recorded a decreased net
      interest margin attributable to increased deposit costs as well as changes
      in
      deposit mix. Management believes that both of these developments are a result
      of
      the generally rising rate environment and flattening yield curve during the
      periods. This development, combined with higher non-interest expenses, fewer
      days in the first quarter as compared to the fourth quarter and seasonal
      variations resulted in the decrease in net income and earnings per share for
      the
      sequential periods.





The
      Company’s efficiency ratio was higher on a linked quarter basis due to higher
      non-interest expenses related to new initiatives designed to improve future
      profitability through enhanced customer relationship management, service
      delivery and branding as well as the decline in net interest margin.





The
      changes in the components of the efficiency ratio combined with volume effects
      resulted in a lower return on assets ratio for the first quarter compared to
      the
      fourth quarter of 2005. Operating profits combined with slower asset growth
      have
      also resulted in higher levels of capital which helped moderate returns on
      equity compared to both for the sequential and year-ago quarters.





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.





-19-


The
      table
      below sets forth changes for the three months ended March 31, 2006 compared
      to
      the same period in 2005 with regard to volume and rate associated with interest
      earning assets and interest bearing deposits.





**Three
                months ended****March
                31. 2006 over 2005****Volume**
            
            **Rate**
            
            **Total**Interest
                income:Loans
                (1)
            
            $
            479
            
            $
            888
            
            $
            1,367Investment
                securities taxable
            
            
            (300
            )
            
            207
            
            
            (93
            )Investment
                securities non-taxable (2):
            
            
            94
            
            
            (52
            )
            
            42Taxable
                equivalent adjustment (2):
            
            
            (32
            )
            
            18
            
            
            (14
            )Interest-bearing
                deposits
            
            
            -
            
            
            -
            
            
            -Federal
                funds sold
            
            
            76
            
            
            80
            
            
            156Net
                increase (decrease)
            
            
            317
            
            
            1,141
            
            
            1,458Interest
                expense:Savings,
                now, money market
            
            
            12
            
            
            357
            
            
            369Time
                deposits
            
            
            196
            
            
            323
            
            
            519Other
                borrowings
            
            
            (345
            )
            
            187
            
            
            (158
            )Long
                term borrowings
            
            
            -
            
            
            44
            
            
            44Net
                increase (decrease)
            
            
            (137
            )
            
            911
            
            
            774Total
                net increase (decrease)
            
            $
            454
            
            $
            230
            
            $
            684








(1)
      Loan
      fees of $350 and $353 for the three months ended March 31, 2006 and 2005,
      respectively have been included in the interest income computation.


(2)
      Adjusted to a fully taxable equivalent basis using a tax rate of
      34%.





Note
      A:
      Average balances of all categories in each period were included in the volume
      computations.


Note
      B:
      Average yield rates in each period were used in rate computations. Change
      attributable to both volume and rate have been allocated in proportion to the
      relationship between their absolute dollar amounts.





-20-





The
      table
      below sets forth the average balance sheet information, interest income and
      expense, average yields and rates and net interest income and margin for the
      three months ended March 31, 2006 and March 31, 2005. The average balance of
      non-accruing loans has been included in loan totals.





**Average
                Balance Sheet Information for the three months ended March
                31,****(in
                thousands)****2006**
            
            
            
            
            
            **2005****Average**
            
            **Yield/**
            
            
            
            **Average**
            
            **Yield/**
            
            **Amount**Interest
                Earning Assets:
            
            **Balance**
            
            **Rate**
            
            **Interest**
            
            **Balance**
            
            **Rate**
            
            **Interest**Interest
                Bearing Dep with other Banks
            
            $
            306
            
            
            3.92
            %
            $
            3
            
            $
            1,998
            
            
            0.60
            %
            $
            3Investment
                securities taxable
            
            
            30,200
            
            
            4.23
            %
            
            319
            
            
            44,483
            
            
            3.70
            %
            
            412Investment
                securities non-taxable
            
            
            15,706
            
            
            4.30
            %
            
            169
            
            
            13,062
            
            
            4.32
            %
            
            141Federal
                funds sold
            
            
            20,640
            
            
            4.39
            %
            
            226
            
            
            11,630
            
            
            2.41
            %
            
            70Loans
                (1) (2)
            
            
            370,083
            
            
            8.09
            %
            
            7,489
            
            
            344,499
            
            
            7.11
            %
            
            6,122Total
                interest earning assets
            
            
            436,935
            
            
            7.51
            %
            
            8,206
            
            
            415,672
            
            
            6.49
            %
            
            6,748Allowance
                for possible loan losses
            
            
            (3,948
            )
            
            
            
            
            
            
            
            (3,326
            )Other
                assets
            
            
            48,802
            
            
            
            
            
            
            
            
            45,547TOTAL
                ASSETS
            
            $
            481,789
            
            
            
            
            
            
            
            $
            457,893Interest
                -bearing liabilities:Savings/NOW/money
                market
            
            
            172,543
            
            
            1.44
            %
            
            620
            
            
            165,675
            
            
            0.61
            %
            
            251Time
                deposits
            
            
            89,973
            
            
            3.70
            %
            
            832
            
            
            60,721
            
            
            2.06
            %
            
            313Other
                borrowings
            
            
            12,670
            
            
            4.39
            %
            
            139
            
            
            36,674
            
            
            3.24
            %
            
            297Long
                Term Debt
            
            
            8,248
            
            
            8.15
            %
            
            168
            
            
            8,248
            
            
            6.01
            %
            
            124Total
                interest-bearing liabilities
            
            
            283,434
            
            
            2.48
            %
            
            1,759
            
            
            271,318
            
            
            1.45
            %
            
            985Demand
                deposits
            
            
            148,020
            
            
            
            
            
            
            
            
            144,718Other
                liabilities
            
            
            4,201
            
            
            
            
            
            
            
            
            3,396Stockholders'
                equityCommon
                stock
            
            
            29,352
            
            
            
            
            
            
            
            
            25,603Retained
                earnings
            
            
            16,884
            
            
            
            
            
            
            
            
            12,721Valuation
                Allowance Investments
            
            
            (102
            )
            
            
            
            
            
            
            
            137Total
                stockholders' equity
            
            
            46,134
            
            
            
            
            
            
            
            
            38,461TOTAL
                LIABILITIES AND STOCKHOLDERS'EQUITY
            
            $
            481,789
            
            
            
            
            
            
            
            $
            457,893Net
                Interest Income
            
            
            
            
            
            
            
            $
            6,447
            
            
            
            
            
            
            
            $
            5,763Net
                Interest Margin (3)
            
            
            
            
            
            5.90
            %
            
            
            
            
            
            
            
            5.55
            %




(1)
            Nonaccrual
                loans have been included in total loans.(2)
            Loan
                fees of $350 and $353 for 2006 and 2005, respectively, have been
                included
                in the interest income computation.(3)
            Net
                interest margin has been calculated by dividing the net interest
                income by
                total average earning assets.


-21-


The
      tables below set forth changes from March 31, 2005 to March 31, 2006 for average
      interest earning assets and their respective average yields. The Company was
      able to increase the loan portfolio with continued market penetration by a
      team
      of seasoned loan officers who are compensated for production. The growth in
      the
      loan portfolio was achieved under the Company’s established Loan Policy. The
      average yield on loans improved by 36 basis points due to action by the Federal
      Reserve Bank of raising rates by 375 basis points from June 2004 through March
      2006. See “Item 3. Quantitative and Qualitative Disclosure about Market Risk”
for further discussion.





The
      tax-exempt portion of the investment portfolio also increased as the Company
      selectively purchased securities available in the marketplace. The Company
      has
      significant ability to increase its holdings of tax-exempt securities before
      becoming subject to the Alternative Minimum Tax. The taxable investment
      portfolio gained in average yield due to rising rates. Taxable investment
      securities decreased due to regular principal reductions on Mortgage Backed
      Securities (MBS).











**Average
                Balance****for
                three months ending**(in
                Thousands)
            
            **March
                31,**Interest
                Earning Assets:
            
            **2006**
            
            **2005**
            
            **$
                Variance**Time
                deposits with other banks
            
            $
            306
            
            $
            1,998
            
            $
            (1,692
            )Investment
                securities taxable
            
            
            30,200
            
            
            44,483
            
            
            (14,283
            )Investment
                securities non-taxable
            
            
            15,706
            
            
            13,062
            
            
            2,644Federal
                funds sold
            
            
            20,640
            
            
            11,630
            
            
            9,010Loans
            
            
            370,083
            
            
            344,499
            
            
            25,584Total
                interest earning assets
            
            $
            436,935
            
            $
            415,672
            
            $
            21,263**Average
                Yield****for
                three months ending****March
                31,**Interest
                Earning Assets:
            
            
            **2006**
            
            
            **2005**
            
            
            **Variance**Time
                deposits with other banks
            
            
            3.92
            %
            
            0.60
            %
            
            3.32
            %Investment
                securities taxable
            
            
            4.23
            %
            
            3.70
            %
            
            0.53
            %Investment
                securities non-taxable
            
            
            4.30
            %
            
            4.32
            %
            
            -0.02
            %Federal
                funds sold
            
            
            4.39
            %
            
            2.41
            %
            
            1.98
            %Loans
            
            
            8.09
            %
            
            7.11
            %
            
            0.98
            %Total
                interest earning assets
            
            
            7.51
            %
            
            6.49
            %
            
            1.02
            %







From
      June
      2004 through March 2006, the Federal Reserve Bank increased rates by a total
      of
      375 basis points. Due to the asset sensitive nature of the Company’s balance
      sheet, these increases, coupled with the Company’s substantial volume of
      non-interest bearing deposits and low average rates on interest bearing
      deposits, are the primary factors for the increase in net interest
      margin.







-22-






The
      tables below set forth changes from March 31, 2005 to March 31, 2006 for average
      interest bearing liabilities and their respective average rates paid.







**Average
                Balance****for
                three months ending**(dollars
                in thousands)
            
            **March
                31,**Interest
                -bearing liabilities:
            
            **2006**
            
            **2005**
            
            **$
                Variance**Savings/NOW/money
                market
            
            $
            172,543
            
            $
            165,675
            
            $
            6,868Time
                deposits
            
            
            89,973
            
            
            60,721
            
            
            29,252Other
                borrowings
            
            
            12,670
            
            
            36,674
            
            
            (24,004
            )Long
                Term Debt
            
            
            8,248
            
            
            8,248
            
            
            -Total
                interest-bearing liabilities
            
            $
            283,434
            
            $
            271,318
            
            $
            12,116**Average
                Yield****for
                three months ending****March
                31,**Interest
                -bearing liabilities:
            
            
            **2006**
            
            
            **2005**
            
            
            **Variance**Savings/NOW/money
                market
            
            
            1.44
            %
            
            0.61
            %
            
            0.83
            %Time
                deposits
            
            
            3.70
            %
            
            2.06
            %
            
            1.64
            %Other
                borrowings
            
            
            4.39
            %
            
            3.24
            %
            
            1.15
            %Long
                Term Debt
            
            
            8.15
            %
            
            6.01
            %
            
            2.14
            %Total
                interest-bearing liabilities
            
            
            2.48
            %
            
            1.45
            %
            
            1.03
            %








The
      ability to attract low cost deposits is part of the Company’s marketing plans
      that have been in place for numerous years. While this remains management’s main
      objective, during 2005 the Company implemented a Time Deposit promotion that
      continues today. This was done to provide appropriate liquidity for current
      and
      anticipated loan funding. This has resulted in an increase in interest bearing
      deposits as well as an increase in deposit costs.





For
      the
      three months ended March 31, 2006, the Company’s average yield on average
      interest earning assets and average yield on average interest bearing
      liabilities both increased just over 1% as compared to the three months ended
      March 31, 2005. The Company’s net interest margin, however, improved as a result
      of the larger balances of interest earning assets as compared to interest
      bearing liabilities during both periods. This result is primarily driven by
      the
      presence of noninterest bearing deposits that also fund earning
      assets.







-23-





Non-Interest
      Income





The
      table
      below sets forth changes for the three months ending March 31, 2006 and March
      31, 2005 for non-interest income.





**For
                Three Months Ended****March
                31,****(in
                thousands)**
            
            **2006**
            
            **2005**
            
            **$
                Variance**
            
            **%
                Variance**Service
                Charges on Deposit Accounts
            
            $
            568
            
            $
            539
            
            $
            29
            
            
            5.38
            %ATM/Debit
                Card Transaction/Interchange Fees
            
            
            175
            
            
            148
            
            
            27
            
            
            18.24
            %Bancard
            
            
            25
            
            
            31
            
            
            (6
            )
            
            -19.35
            %Mortgage
                Origination Fees
            
            
            143
            
            
            197
            
            
            (54
            )
            
            -27.41
            %Earnings
                on Cash Surrender Value Life Ins
            
            
            84
            
            
            72
            
            
            12
            
            
            16.67
            %Gain
                on Sale SBA Loans
            
            
            19
            
            
            34
            
            
            (15
            )
            
            -44.12
            %Other
            
            
            204
            
            
            111
            
            
            93
            
            
            83.78
            %**TOTAL**
            
            **$**
            **1,218**
            
            **$**
            **1,132**
            
            **$**
            **86**
            
            
            **7.60**
            **%**








Increases
      in Service Charges on Deposit Accounts and ATM/Debit Card related transactions
      were favorably impacted by an $11.8 million increase in core Demand Deposits
      over the one year period net of variation in large volatile deposit
      relationships as described under Financial Condition below. The average balance
      of demand deposits during the first three months of 2006 was $148.0 million
      as
      compared to $144.7 million for the first three months of 2005. The higher
      average balance combined with the noted increase in retail core demand deposits
      lead to the increases in service charges and interchange fees in the first
      quarter of 2006 over the comparable period in 2005.





Mortgage
      Origination Fees were negatively impacted by reduced mortgage volumes for the
      first quarter of 2006. Mortgage volumes in terms of dollar volume and number
      of
      loans were down approximately 30% for the first three months of 2006 compared
      to
      the same period in 2005 with the market rebounding somewhat toward the end
      of
      the first quarter 2006. Typically, the first quarter is also a lower volume
      quarter than the remainder of the year and the Company expects that volumes
      will
      increase through the spring and summer of 2006.





Non-Interest
      Expenses





The
      table
      below sets forth changes for the three months ended March 31, 2006 and March
      31,
      2005 for non-interest expense.





**For
                Three Months Ended****March
                31,****(in
                thousands)**
            
            **2006**
            
            **2005**
            
            **$
                Variance**
            
            **%
                Variance**Salaries
                and Employee Benefits
            
            $
            2,783
            
            $
            2,248
            
            $
            535
            
            
            23.80
            %Occupany
                and Equipment
            
            
            622
            
            
            612
            
            
            10
            
            
            1.63
            %Data
                Processing
            
            
            528
            
            
            579
            
            
            (51
            )
            
            -8.81
            %Advertising
                and promotional
            
            
            185
            
            
            127
            
            
            58
            
            
            45.67
            %Regulatory
                fees
            
            
            29
            
            
            25
            
            
            4
            
            
            16.00
            %Other
                professional fees and outside services
            
            
            240
            
            
            119
            
            
            121
            
            
            101.68
            %Legal
                fees and other litigation expense
            
            
            17
            
            
            37
            
            
            (20
            )
            
            -54.05
            %Loan
                Department Costs
            
            
            33
            
            
            42
            
            
            (9
            )
            
            -21.43
            %Stationery
                and supplies
            
            
            69
            
            
            86
            
            
            (17
            )
            
            -19.77
            %Director
                fees
            
            
            76
            
            
            48
            
            
            28
            
            
            58.33
            %Core
                Deposit Intangible Amortization
            
            
            75
            
            
            143
            
            
            (68
            )
            
            -47.55
            %Other
            
            
            327
            
            
            357
            
            
            (30
            )
            
            -8.40
            %**$**
            **4,984**
            
            **$**
            **4,423**
            
            **$**
            **561**
            
            
            **12.68**
            **%**







-24-


Salary/Related
      Expense




Salaries
      and employee related expense incurred the greatest dollar increase of any
      non-interest expense category for the three months ending March 31, 2006 and
      2005. The increase was primarily due to the increase in the number of employees
      at the Company year over year as the Company seeks to further penetrate existing
      markets and enhance customer service and to higher group insurance premiums
      in
      2006. The Company also began to expense compensation cost of stock options
      related to the implementation of SFAS 123R in the first quarter of 2006. Stock
      options expense recorded for the first quarter of 2006 was $74,000.
      Historically, many of the Company’s stock option grants have occurred during the
      first quarter of the year. Due to the subsequent vesting of these options during
      first quarter annually, the Company should experience higher options expense
      in
      the first quarter than in the coming quarters this year. The Company estimates
      approximately $43,000 additional options expense to be incurred in 2006.





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, audit fees, compliance and insurance costs.





Advertising
      and Promotional


The
      increase in advertising and promotional expenses was primarily a result of
      increases in professional fees related to the new marketing initiatives designed
      to enhance customer relationship management, service delivery and
      branding.





Provision
      for Income Taxes





The
      provision for income taxes was 37.3% and 38.2% of net pre-tax income for the
      three months ending March 2006, and 2005, respectively.





FINANCIAL
      CONDITION ANALYSIS





Total
      assets of the Company were $492.5 million at March 31, 2006 compared to $488.5
      million at December 31, 2005. This represents an increase of $4.0 million or
      0.8% for the quarter.





Loans





The
      table
      below sets forth changes from December 31, 2005 to March 31, 2006 for the
      composition of the loan portfolio.





**March
                31,**
            
            **December
                30,****2006**
            
            **2005**
            
            **$Variance**
            
            **%Variance****(in
                thousands)**Commercial,
                financial, and agricultural
            
            $
            65,079
            
            $
            60,050
            
            $
            5,029
            
            
            8.37
            %Real
                estate-construction
            
            
            86,533
            
            
            76,981
            
            
            9,552
            
            
            12.41
            %Real
                Estate - other
            
            
            208,271
            
            
            210,690
            
            
            (2,419
            )
            
            -1.15
            %Home
                equity lines of credit
            
            
            13,168
            
            
            14,398
            
            
            (1,230
            )
            
            -8.54
            %Installment
                loans to individuals
            
            
            5,418
            
            
            5,620
            
            
            (202
            )
            
            -3.59
            %All
                other loans (including overdrafts)
            
            
            251
            
            
            394
            
            
            (143
            )
            
            -36.29
            %378,720
            
            
            368,133
            
            
            10,587
            
            
            2.88
            %Less
                - deferred loan fees, net
            
            
            (1,526
            )
            
            (1,617
            )
            
            91
            
            
            -5.63
            %Less
                - reserve for possible loan losses
            
            
            (4,005
            )
            
            (3,881
            )
            
            (124
            )
            
            3.10
            %Total
                loans
            
            $
            373,189
            
            $
            362,635
            
            $
            10,554
            
            
            2.91
            %Loans
                Held For Sale
            
            $
            2,994
            
            $
            3,392
            
            $
            (398
            )
            
            -11.73
            %




The
      increase in commercial, financial and agricultural loans is attributed primarily
      to a $2.3 million new line of credit to a winery, a $5 million line of credit
      to
      a financial services company and several other business credit lines.





-25-


The
      increase in real estate-construction and land loans can be attributed to several
      large new construction projects and the funding of existing construction
      projects. New loans include a strip center for $4.0 million, an office complex
      for $1.7 million, an office building for $1.2 million, a spec residence for
      $1.6
      million, 2 loans on land for tract development of $1.2 & $1.3 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 25 years with 10 to 15 year maturities.





The
      decrease in real estate-mortgage loans is attributed to several loans refinanced
      and paid off through out of area lenders and mortgage brokers. Several new
      loans
      were booked during the period including a hotel for $5.4 million, an office
      building for $1.0 million and several smaller real estate loans.





The
      Bank
      presently has a concentration of loans in construction/land in the amount of
      $86.5 million which represents 173% of the Bank’s Total Risk Based capital. Of
      this, 43% are owner occupied. Un-disbursed commitments total $59.0 million
      which
      combined with disbursed represent 292% of the Bank’s Total Risk based Capital
      with 104% owner occupied. At March 31, 2006 there were 82 construction loans
      with outstanding balances and remaining commitments of approximately $66.1
      million and $59 million, respectively. The single largest construction loan
      has
      a commitment amount of approximately $10.7 million with a balance of
      approximately $4.0 million at March 31, 2006. This is an office complex in
      San
      Luis Obispo, Ca. At March 31, 2006, there were 57 land loans with balances
      of
      approximately $20.4 million. The single largest land loan accounts for
      approximately $1.6 million of the total and is for a mixed use development.
      The
      construction/land loans are spread throughout the Company’s market area and have
      consistently performed in a satisfactory manner.





Hotel
      loans disbursed are not considered to be a concentration with balances of $40.4
      million which represents 82% of the Bank’s Total Risk Based Capital. However,
      there are several hotel construction loans that increase total outstandings
      to
      $51.3 million and total commitments to $62.8 million which represents a
      concentration at 126% of the Bank’s Total Risk Based Capital. At March 31, 2006,
      there were 33 motel loans. The single largest loan had a balance of
      approximately $6.3 million, was made to a nationally known chain and is located
      in Paso Robles, California. The hotel loans are also made to clients throughout
      the Company’s markets. These loans have also typically 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 the expansion of an assisted living facility in San Luis Obispo.
      Approximately $6.6 million of the funds were deposited with the Bank with $2.2
      million remaining at March 31, 2006. These funds are being used for capital
      improvements to the assisted living facility. The project is approximately
      70%
      complete and should be finished in mid 2006. The letter of credit will expire
      in
      September 2007.





Construction
      loan demand for both single family and commercial real estate moderated during
      the first two months of 2006 and then increased in March. Increased interest
      rates and construction costs impacted commercial real estate activity. Area
      home
      prices continue to increase however they remain considerably lower than the
      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 continued availability of land for subdivision
      use
      also continued to drive the market in the North San Luis Obispo County and
      Santa
      Maria markets. Builders are moving to the more rural communities in order to
      construct more affordable homes. This has translated to increased commuter
      traffic and the need for more transportation infrastructure.





Business
      properties are also in demand with low vacancies and competitive but increasing
      loan rates. Commercial property values and rental rates increased substantially
      during 2005 and have slowed somewhat thus far in 2006. Investors, many seeking
      exchange properties, continue to seek properties in the Company’s market area.
      Capitalization rates have steadily decreased with increased demand.
      Capitalization rate ranges over the last three years are: 2003- 7.0% to 8.0%,
      2004- 6.5% to 7.5% and 2005- 5.5% to 6.5%. Properties typically require larger
      down payments in order to satisfy bank debt coverage requirements. The Bank
      expects to experience continued growth in commercial real estate loans during
      2006 but most likely at a slower pace than 2005. Interest rate margins are
      expected to decrease somewhat do to competitive pressures.




-26-


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, 2006, 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 that 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’s provision for loan losses was $120,000 for the first quarter of 2006,
      compared to $180,000 for the same period 2005.  The
      provision amount is based on the Bank’s monthly allowance for loan losses
      calculation including current plans for recovery collection.





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. Payments that
      are
      received may also be applied to reduce the principal balance. 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.





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.





Loans
      on
      non-accrual status totaled $52,000 and $54,000 at March 31, 2006 and December
      31, 2005, respectively. Typically, these loans have adequate collateral
      protection and/or personal guaranties to provide a source of repayment to the
      Bank. Most of the loans on non-accrual are related to several commercial loans
      that are being addressed by specific workout plans at this time. Interest income
      that would have been recognized on non-accrual loans if they had performed
      in
      accordance with the terms of the loans was approximately $1,282 and $87,343
      for
      the period ended March 31, 2006 and December 31, 2005,
      respectively.





Non-performing
      loans include non-accrual loans, restructured loans and accruing loans that
      are
      90 days or more delinquent. Non-performing loans totaled $52,000 at March 31,
      2006 and $54,000 at December 31, 2005. There were no loans past due 90 days
      or
      more and still accruing interest at March 31, 2006.




Non-performing
      loans were 0.01% of total assets as of March 31, 2006 and December 31, 2005,
      respectively. The allowance for loan loss to non-performing loans was 77.0x
      and
      71.9x at March 31, 2006 and December 31, 2005, respectively.





Total
      Cash and Due from Banks





Total
      cash and due from banks were $17.4 million and $18.3 million at March 31, 2006
      and December 31, 2005, respectively. This line item will vary depending on
      cash
      letters from the previous night and actual cash on hand in the branches.





-27-


Investment
      Securities and Other Earning Assets





Other
      earning assets are comprised of Federal Home Loan Bank, Federal Funds sold
      (funds lent 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 the composition of other earning assets for March 31, 2006
      and
      December 31, 2005. Interest bearing deposits with other financial institutions
      increased by $20,000 due to an investment on a CRA Micro Loan fund. Fed Funds
      Sold decreased due primarily to an increase in the loan portfolio and relatively
      slower growth in deposits for the quarter. Deposit growth was moderated by
      a
      decline in volatile deposit relationship balances.





**March
                31,**
            
            **December
                31,****2006**
            
            **2005****(in
                thousands)**Federal
                Home Loan Bank, and other stock
            
            $
            1,907
            
            $
            1,885Available-for-Sale
                Investments
            
            
            43,847
            
            
            44,402Federal
                Funds Sold
            
            
            20,475
            
            
            26,280Interest
                Bearing Deposits other fin inst.
            
            
            318
            
            
            298Total
                Other Earning Assets
            
            $
            66,547
            
            $
            72,865




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, 2005, net unrealized losses in the portfolio were
      $158 thousand compared to a net unrealized loss of $146 thousand at March 31,
      2006. The portfolio decreased in size due to principle reductions on Mortgage
      Backed Securities.





At
      March
      31, 2006, available-for-sale securities in the portfolio included obligations
      of
      state and political subdivisions, obligations of US government agencies and
      corporations and mortgaged 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.







Deposits
      and Borrowed Funds





The
      table
      below sets forth changes from December 31, 2005 to March 31, 2006 for the
      composition of deposit categories.






-28-





**March
                31,**
            
            **December
                31,****(in
                thousands)**
            
            **2006**
            
            **2005**
            
            **$Variance**
            
            **%Variance**Deposits:Demand,
                non-interest bearing
            
            $
            156,406
            
            $
            164,014
            
            
            (7,608
            )
            
            -4.64
            %Interest
                bearing demand
            
            
            54,701
            
            
            50,598
            
            
            4,103
            
            
            8.11
            %Savings
            
            
            26,758
            
            
            29,386
            
            
            (2,628
            )
            
            -8.94
            %Money
                market
            
            
            91,962
            
            
            90,122
            
            
            1,840
            
            
            2.04
            %Time
                deposits of $100 or more
            
            
            17,229
            
            
            17,414
            
            
            (185
            )
            
            -1.06
            %Time
                deposits under $100
            
            
            74,663
            
            
            66,263
            
            
            8,400
            
            
            12.68
            %Total
                deposits
            
            $
            421,719
            
            $
            417,797
            
            $
            3,922
            
            
            0.94
            %





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. Friendly competition between the branch
      offices to increase deposit totals has been in place for two years. The branch
      offices are all given goals for each deposit category type and results are
      measured monthly. Lending and Operational staff work together to meet or beat
      their goals. This program has generated a significant amount of pride for the
      entire staff and resulted in growth for the Company.





For
      the
      Company, at March 31, 2006, non-interest bearing demand deposits provide 37%
      of
      total deposits compared to 39% at December 31, 2005. The Bank has 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. The volatile
      nature of these relationships was evidenced by an decrease of $15.6 million
      in
      these account balances from December 31, 2005 to March 31, 2006. As a percentage
      of total deposits, these accounts represented 15.7% at December 31, 2005
      compared to 11.8% at March 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 $100,000, 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 $404.5 million represented
      95.9% of total deposits at March 31, 2006. The Company does not purchase funds
      through deposit brokers.





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, 2006, 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, 2006, the interest rate on the note was 7.75% 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, 2006, the Bank had borrowings with the FHLB of $10.0 million collateralized
      by loans. The borrowings mature in July 2006. 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.





-29-


At
      March
      31, 2006, the Bank has a remaining borrowing capacity with existing collateral
      of approximately $78.6 million and $12.0 million secured by loans and
      securities, respectively.





The
      Bank
      utilizes securities sold under repurchase agreements as a source of funds.
      The
      Bank had $3,8 million in securities sold under repurchase agreements at December
      31, 2005 compared to $2.0 million at March 31, 2006.





Capital





The
      Company's total stockholders equity was $44.8 million at December 31, 2005
      compared to $46.7 million at March 31, 2006. The increase in capital was due
      to
      net income of $1.6 million, stock options exercised in the amount of $192
      thousand, the capital impact of stock options expense of $74 thousand, and
      an
      increase in accumulated other comprehensive income of $12 thousand.





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.





On
      March
      25, 2005 the Board of Directors of the Company announced a 5% stock dividend
      to
      shareholders of record on April 8, 2005 that was distributed on April 22, 2005.
      On October 21, 2005, the Board of Directors declared a 50% stock split payable
      on December 2, 2005 to stockholders of record on November 10, 2005. The
      Consolidated Statements of Stockholders’ Equity found under “Item 1. Financial
      Statements” in this document reflects the 5% stock dividend and the 50% stock
      split.





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 8.15% as of March 31, 2006. 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 $248,000 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.





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.




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.





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 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. At March 31, 2006, the Company has
      included the net junior subordinated debt in its Tier1 Capital for regulatory
      capital purposes.





-30-


Management
      believes that organic growth in 2006 for the Company can be accomplished without
      further borrowing for capital or cash flow purposes. At March 31, 2006, the
      Company had sufficient cash to service the $8.2 million in junior subordinated
      debenture interest payments for approximately seventeen quarters without
      dividends from its subsidiary. The Bank’s capacity to provide cash to the
      Company, while remaining “well-capitalized”, was $6.7 million at March 31, 2006.





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 the fact 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, 2006.




**Regulatory
                Standard****Adequately**
            
            **Well****Capitalized**
            
            **Capitalized**
            
            **Company**
            
            **Bank**Leverage
                Ratio
            
            
            4.00
            %
            
            5.00
            %
            
            10.23
            %
            
            9.71
            %Tier
                One Risk Based Captial Ratio
            
            
            4.00
            %
            
            6.00
            %
            
            11.20
            %
            
            10.59
            %Total
                Risk Based Captial Ratio
            
            
            8.00
            %
            
            10.00
            %
            
            12.16
            %
            
            11.55
            %








For
      the
      Company, all $8 million of the trust preferred securities are accounted for
      as
      Tier I Capital for purposes of calculating Regulatory Capital.





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 the Bank’s customers serve as
      the primary source of liquidity. The Bank has credit arrangements with
      correspondent banks that serve as a secondary liquidity source. At March 31,
      2006, these credit lines totaled $13.4 million and the Bank had no borrowings
      against those lines. The Bank is a member of the FHLB and has collateralized
      borrowing capacities remaining of $90.7 million at March 31, 2006.





The
      Bank
      manages liquidity by maintaining a majority of the investment portfolio in
      federal funds sold and other liquid investments. At March 31, 2006, the ratio
      of
      liquid assets not pledged for collateral and other purposes to deposits and
      other liabilities was 14.0% compared to 16.1% at December 31, 2005. The ratio
      of
      net loans to deposits, another key liquidity ratio, was 88.5% at March 31,
      2006
      compared to 86.8% at December 31, 2005





-31-


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. Inflation has been significant to the
      Company’s financial position and results of operations with regard to
      fluctuation in interest rates impacting net interest margins. However, inflation
      has not, in recent periods, been a significant factor in customers’ ability to
      repay debt or in upward pressure on the Company’s operating expenses.





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 7 of Part II of the Company’s December 31, 2005 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 7 of Part II of
      the Company’s December 31, 2005 10-K.





In
      connection with the $8.2 million in debt securities discussed in “Capital,” the
      Company issued the full and unconditional payment guarantee of certain accrued
      distributions.





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 $8 million in
      subordinated debentures issued by the Company’s subsidiary grantor trust. As a
      result, all significant interest rate risk procedures are performed at the
      banking subsidiary level. The 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.




-32-


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, 2006
      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.





**Rate
                Shock Scenarios****(dollars
                in Thousands)****-200bp**
            
            **-100bp**
            
            **Base**
            
            **+100bp**
            
            **+200bp**Net
                Interest Income (NII)
            
            $
            22,950
            
            $
            24,531
            
            $
            26,219
            
            $
            27,810
            
            $
            29,395$
                Change from Base
            
            $
            (3,269
            )
            $
            (1,688
            )
            $
            -
            
            $
            1,591
            
            $
            3,177%
                Change from Base
            
            
            -12.47
            %
            
            -6.44
            %
            
            0.00
            %
            
            6.07
            %
            
            12.12
            %








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.







-33-





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)**%
                of**Gross
                Loans
            
            **Balance**
            
            **Total**Variable-Daily
            
            $
            165,800
            
            
            44
            %Variable-Other
                than daily
            
            
            153,176
            
            
            40
            %Fixed
            
            
            59,744
            
            
            16
            %Total
                Gross Loans
            
            $
            378,720
            
            
            100
            %Gross
                Loans
            
            **%
                of**Re-Pricing
            
            
            **Balance**
            
            
            **Total**<
                1 Year
            
            $
            233,115
            
            
            62
            %1-3
                Years
            
            
            89,178
            
            
            24
            %3-5
                Years
            
            
            41,579
            
            
            11
            %>
                5 Years
            
            
            14,848
            
            
            4
            %$
            378,720
            
            
            100
            %





The
      table
      above identifies approximately 44% of the loan portfolio that will re-price
      immediately in a rising rate environment.





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 Rule 13a-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, 2006 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.








-34-


PART
      2.
      OTHER INFORMATION





Item
      1.  Legal
      Proceedings


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





Item
      1A.
      Risk Factors


There
      have been no material changes to the risk factors previously disclosed in the
      Company’s 10-K for the year ended December 31, 2005





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


N/A





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








-35-


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
      10, 2006


By:
            /s/ Lawrence
              P. WardLawrence
                P. Ward
              President
              Chief
                Executive Officer


By:
              /s/ Margaret
                A. TorresMargaret
                  A. Torres
                  Chief
                    Financial Officer
                  Executive
                    Vice President


-36-


EXHIBIT
      INDEX





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






-37-