**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-Q**





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


**THE
      SECURITIES EXCHANGE ACT OF 1934**





**FOR
      THE QUARTERLY PERIOD ENDED JUNE 30, 2007**





**OR**





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


**FOR
      THE TRANSITION PERIOD FROM** _______ **to
      _______**





**COMMISSION
      FILE NO.** **0-25020**





**HERITAGE
      OAKS BANCORP**


(Exact
      name of registrant as specified in charter)


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




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


(Address
      of principal office)





**(805)
      239-5200**


(Registrant's
      telephone number, including area code)





**Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding twelve (12) months (or for such shorter period that the registrant
      was
      required to file such reports), and (2) has been subject to such filing
      requirements for the past ninety (90) days.**





**YES
      x NO
o**




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





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




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





**YES o NO
      x**




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





**As
      of July 25, 2007 there were approximately 6,475,403 shares outstanding of the
      Registrant’s common stock.**


-1-




**TABLE
      OF CONTENTS**


Part
                    1. Financial Information
                3Item
                    1. Consolidated Financial Statements (Un-audited, except for
                    Balance Sheet
                    as of 12/31/2006)
                3Consolidated
                    Balance Sheets
                4Consolidated
                    Statements of Operations
                5Consolidated
                    Statement of Changes in Stockholders’ Equity
                6Consolidated
                    Statements of Comprehensive Income
                7Consolidated
                    Statements of Cash Flows
                8Notes
                    to Consolidated Financial Statements
                9Item
                      2. Management’s Discussion and Analysis ofFinancial Condition
                    and Results of Operations
                17Item
                    3. Quantitative and Qualitative Disclosure about Market
                    Risk
                39Item
                    4. Controls and Procedures
                40Part
                    2. Other Information
                41Item
                    1.Legal Proceedings
                41Item
                    1.A. Risk Factors
                41Item
                    2.Unregistered Sales of Equity Securities and Use of
                    Proceeds
                41Item
                    3.Defaults Upon Senior Securities
                42Item
                    4.Submission of Matters to a Vote of Security Holders
                42Item
                    5.Other Information
                42Item
                    6.Exhibits
                42Signatures
                43CertificationsExhibits


-2-





PART
      1.
      FINANCIAL INFORMATION





**Item
      1. Financial Statements**





The
      financial statements and notes begin on next page.




-3-




**HERITAGE
                OAKS BANCORP****CONSOLIDATED
                BALANCE SHEETS***(dollars
                amounts in thousands)*




**(Unaudited)**
            
            **(1)****June
                30,**
            
            **December
                31,****2007**
            
            **2006****ASSETS**Cash
                and due from banks
            
            $
            20,945
            
            $
            19,164Federal
                funds sold
            
            
            43,505
            
            
            3,870Total
                cash and cash equivalents
            
            
            64,450
            
            
            23,034Interest
                bearing deposits with other banks
            
            
            318
            
            
            318Securities
                available for sale
            
            
            36,018
            
            
            38,445Federal
                Home Loan Bank stock, at cost
            
            
            3,119
            
            
            2,350Loans
                held for sale
            
            
            3,329
            
            
            1,764Loans,
                net (2)
            
            
            453,900
            
            
            439,277Property,
                premises and equipment, net
            
            
            5,057
            
            
            14,581Cash
                surrender value of life insurance
            
            
            9,621
            
            
            9,435Deferred
                tax assets
            
            
            4,656
            
            
            2,414Goodwill
            
            
            4,864
            
            
            4,865Core
                deposit intangible
            
            
            971
            
            
            1,148Other
                assets
            
            
            3,562
            
            
            4,143**TOTAL
                ASSETS**
            
            $
            589,865
            
            $
            541,774**LIABILITIES**Deposits:Demand,
                non-interest bearing
            
            $
            153,485
            
            $
            153,005Savings,
                NOW, and money market deposits
            
            
            193,720
            
            
            146,110Time
                deposits of $100 or more
            
            
            44,141
            
            
            30,630Time
                deposits under $100
            
            
            97,761
            
            
            90,776Total
                deposits
            
            
            489,107
            
            
            420,521FHLB
                advances and other borrowed money
            
            
            30,000
            
            
            50,000Securities
                sold under agreement to repurchase
            
            
            1,358
            
            
            1,364Junior
                subordinated debentures
            
            
            8,248
            
            
            16,496Other
                liabilities
            
            
            8,631
            
            
            3,921Total
                liabilities
            
            
            537,344
            
            
            492,302Commitments
                and contingencies
            
            
            -
            
            
            -**STOCKHOLDERS'
                EQUITY**Common
                stock, no par value;20,000,000
                shares authorized; issued and outstanding6,476,403
                and 6,345,639 as of June 30, 2007 and
                December 31, 2006, respectively.
            
            
            30,072
            
            
            29,247Additional
                paid in capital
            
            
            520
            
            
            336Retained
                earnings
            
            
            22,096
            
            
            19,809Accumulated
                other comprehensive (loss) / income
            
            
            (167
            )
            
            80Total
                stockholders' equity
            
            
            52,521
            
            
            49,472**TOTAL
                LIABILITIES & STOCKHOLDERS' EQUITY**
            
            $
            589,865
            
            $
            541,774




(1)
                These numbers have been derived from the audited financial
                statements.(2)
                Loans net of deferred fees of $1,559 and $1,625 and allowance for
                loan
                loss of $4,520 and $4,081 at June 30, 2007 and December 31, 2006,
                respectivelySee
                notes to condensed consolidated financial statements.


-4-





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




**For
                the three months**
            
            **For
                the six months****ended
                June 30,**
            
            **ended
                June 30,****2007**
            
            **2006**
            
            **2007**
            
            **2006**Interest
                Income:Interest
                and fees on loans
            
            $
            10,214
            
            $
            8,018
            
            $
            20,029
            
            $
            15,507Investment
                securities
            
            
            437
            
            
            490
            
            
            885
            
            
            978Federal
                funds sold and commercial paper
            
            
            162
            
            
            156
            
            
            193
            
            
            382Time
                certificates of deposit
            
            
            10
            
            
            2
            
            
            18
            
            
            5Total
                interest income
            
            
            10,823
            
            
            8,666
            
            
            21,125
            
            
            16,872Interest
                Expense:Now
                accounts
            
            
            43
            
            
            23
            
            
            71
            
            
            44MMDA
                accounts
            
            
            946
            
            
            549
            
            
            1,613
            
            
            1,120Savings
                accounts
            
            
            23
            
            
            26
            
            
            47
            
            
            53Time
                deposits of $100 or more
            
            
            301
            
            
            117
            
            
            510
            
            
            256Other
                time deposits
            
            
            1,276
            
            
            846
            
            
            2,488
            
            
            1,539Other
                borrowed funds
            
            
            976
            
            
            470
            
            
            2,105
            
            
            778Total
                interest expense
            
            
            3,565
            
            
            2,031
            
            
            6,834
            
            
            3,790Net
                interest income before provision for possible loan losses
            
            
            7,258
            
            
            6,635
            
            
            14,291
            
            
            13,082Provision
                for loan losses
            
            
            170
            
            
            180
            
            
            310
            
            
            300Net
                interest income after provision for loan losses
            
            
            7,088
            
            
            6,455
            
            
            13,981
            
            
            12,782Non-Interest
                Income:Service
                charges on deposit accounts
            
            
            686
            
            
            613
            
            
            1,299
            
            
            1,181Other
                income
            
            
            705
            
            
            598
            
            
            1,324
            
            
            1,248Total
                non-interest income
            
            
            1,391
            
            
            1,211
            
            
            2,623
            
            
            2,429Non-Interest
                Expense:Salaries
                and employee benefits
            
            
            3,194
            
            
            2,786
            
            
            6,444
            
            
            5,568Occupancy
                and equipment
            
            
            706
            
            
            665
            
            
            1,421
            
            
            1,268Other
                expenses
            
            
            1,663
            
            
            1,597
            
            
            3,391
            
            
            3,195Total
                non-interest expenses
            
            
            5,563
            
            
            5,048
            
            
            11,256
            
            
            10,031Income
                before provision for income taxes
            
            
            2,916
            
            
            2,618
            
            
            5,348
            
            
            5,180Provision
                for applicable income taxes
            
            
            1,116
            
            
            945
            
            
            2,037
            
            
            1,900Net
                Income
            
            $
            1,800
            
            $
            1,673
            
            $
            3,311
            
            $
            3,280Earnings
                per share:Basic
            
            $
            0.28
            
            $
            0.26
            
            $
            0.52
            
            $
            0.52Fully
                Diluted
            
            $
            0.27
            
            $
            0.25
            
            $
            0.50
            
            $
            0.49




See
                notes to condensed consolidated financial
                statements


-5-





**HERITAGE
                OAKS BANCORP****CONSOLIDATED
                STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED)****June
                30, 2007 and 2006***(amounts
                in thousands except shares
                outstanding)*




**Common
                    Stock**
                
                **Additional**
                
                
                
                
                
                **Accumulated**
                    **Other**
                
                **Total****Number of**
                
                
                
                **Paid-In**
                
                **Comprehensive**
                
                **Retained**
                
                **Comprehensive**
                
                **Stockholders'****Shares**
                
                **Amount**
                
                **Capital**
                
                **Income**
                
                **Earnings**
                
                **Income**
                
                **Equity****Balance,
                    December 31, 2006**
                
                
                6,345,639
                
                $
                29,247
                
                $
                336
                
                
                
                
                $
                19,809
                
                $
                80
                
                $
                49,472Exercise
                    of stock options
                  (including
                    $440 tax benefit from exercise of stock options)
                
                
                129,764
                
                
                825
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                825Cash
                    dividend of $0.08 per share paid on February 16, 2007
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (510
                )
                
                
                
                
                (510
                )Cash
                    dividend of $0.08 per share paid on May 18, 2007
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (514
                )
                
                
                
                
                (514
                )Share-based
                    compensation expense
                
                
                
                
                
                
                
                
                184
                
                
                
                
                
                
                
                
                
                
                
                184Issuance
                    of restricted stock awards
                
                
                1,000
                
                
                -
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                -Comprehensive
                    income:Net
                    income
                
                
                
                
                
                
                
                
                
                
                
                3,311
                
                
                3,311
                
                
                
                
                
                3,311Unrealized
                    security holding losses (net of $164 tax benefit)
                
                
                
                
                
                
                
                
                
                
                
                (247
                )
                
                
                
                
                (247
                )
                
                (247
                )Total
                    comprehensive income
                
                
                
                
                
                
                
                
                
                
                $
                3,064**Balance,
                    June 30, 2007**
                
                
                6,476,403
                
                $
                30,072
                
                $
                520
                
                
                
                
                $
                22,096
                
                $
                (167
                )
                $
                52,521**Balance,
                    December 31, 2005**
                
                
                6,231,982
                
                $
                29,255
                
                
                
                
                
                
                
                $
                15,748
                
                $
                (158
                )
                $
                44,845Exercise
                    of stock options
                  (including
                    $160 tax benefit from exercise of stock options)
                
                
                46,164
                
                
                323
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                323Cash
                    dividend of $0.25 per share paid on May 19, 2006
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (1,586
                )
                
                
                
                
                (1,586
                )Share-based
                    compensation expense
                
                
                
                
                
                74
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                74Issuance
                    of restricted stock awards
                
                
                70,050
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                -Comprehensive
                    income:Net
                    income
                
                
                
                
                
                
                
                
                
                
                
                3,280
                
                
                3,280
                
                
                
                
                
                3,280Unrealized
                    security holding losses (net of $344 tax benefit)
                
                
                
                
                
                
                
                
                
                
                
                (357
                )
                
                
                
                
                (357
                )
                
                (357
                )Total
                    comprehensive income
                
                
                
                
                
                
                
                
                
                
                $
                2,923**Balance,
                    June 30, 2006**
                
                
                6,348,196
                
                $
                29,652
                
                $
                -
                
                
                
                
                $
                17,442
                
                $
                (515
                )
                $
                46,579
  See
                  notes to condensed consolidated financial
                  statements


-6-





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




**For
                the three months**
            
            **For
                the six months****ended
                June 30,**
            
            **ended
                June 30,****2007**
            
            **2006**
            
            **2007**
            
            **2006****Net
                Income**
            
            $
            1,800
            
            $
            1,673
            
            $
            3,311
            
            $
            3,280**Other
                comprehensive (loss) / income before taxes:**Unrealized
                gains / (losses) on securities available for sale:Unrealized
                holding (losses) arising during period
            
            
            (488
            )
            
            (1,102
            )
            
            (411
            )
            
            (701
            )Other
                comprehensive (loss) before taxes
            
            
            (488
            )
            
            (1,102
            )
            
            (411
            )
            
            (701
            )Income
                tax benefit related to items in comprehensive income
            
            
            195
            
            
            441
            
            
            164
            
            
            344**Other
                comprehensive (loss), net of taxes**
            
            
            (293
            )
            
            (661
            )
            
            (247
            )
            
            (357
            )**Comprehensive
                income**
            
            $
            1,507
            
            $
            1,012
            
            $
            3,064
            
            $
            2,923




See
                notes to condensed consolidated financial
                statements





-7-




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




**For
                the six month****periods
                ended June 30,****2007**
            
            **2006**Cash
                flows from operating activities:Net
                income
            
            $
            3,311
            
            $
            3,280Adjustments
                to reconcile net income to net cash provided by operating
                activities:Depreciation
                and amortization
            
            
            509
            
            
            430Provision
                for possible loan losses
            
            
            310
            
            
            300Amortization
                of premiums/discounts on investment securities, net
            
            
            (41
            )
            
            (2
            )FHLB
                stock dividends received
            
            
            (64
            )
            
            (45
            )Amortization
                of intangible assets
            
            
            177
            
            
            150Share-based
                compensation expense
            
            
            184
            
            
            74(Increase)
                in loans held for sale
            
            
            (1,565
            )
            
            (2,724
            )Net
                (increase) in cash surrender value of life insurance
            
            
            (186
            )
            
            (150
            )(Increase)
                in deferred tax asset
            
            
            (2,078
            )
            
            -Decrease/(increase)
                in other assets
            
            
            582
            
            
            (145
            )Excess
                tax benefit related to share-based compensation expense
            
            
            (440
            )
            
            (160
            )Increase/(decrease)
                in other liabilities
            
            
            5,150
            
            
            (387
            )**NET
                CASH PROVIDED BY OPERATING ACTIVITIES**
            
            
            5,849
            
            
            621Cash
                flows from investing activities:Net
                change in time deposits
            
            
            -
            
            
            (20
            )Purchase
                of available-for-sale securities
            
            
            -
            
            
            (1,190
            )Proceeds
                from principal reductions and maturitiesof
                available-for-sale mortgage backed securities
            
            
            2,057
            
            
            3,587Purchase
                of FHLB stock
            
            
            (705
            )
            
            -Purchase
                of life insurance policies
            
            
            -
            
            
            (1,386
            )Increase
                in loans, net
            
            
            (15,062
            )
            
            (23,489
            )Allowance
                for loan and lease loss recoveries
            
            
            129
            
            
            16Purchase
                of property, premises and equipment, net
            
            
            (386
            )
            
            (3,018
            )Proceeds
                from sale of property, premises and equipment
            
            
            9,401
            
            
            -**NET
                CASH (USED IN) INVESTING ACTIVITIES**
            
            
            (4,566
            )
            
            (25,500
            )Cash
                flows from financing activities:Increase
                in deposits, net
            
            
            68,586
            
            
            12,363(Decrease)/increase
                in FHLB borrowing
            
            
            (20,000
            )
            
            20,000Decrease
                in repurchase agreements
            
            
            (6
            )
            
            (1,832
            )Decrease
                in junior subordinated debentures
            
            
            (8,248
            )
            
            -Excess
                tax benefit related to share-based compensation expense
            
            
            440
            
            
            160Proceeds
                from exercise of stock options
            
            
            385
            
            
            163Cash
                dividends paid
            
            
            (1,024
            )
            
            (1,586
            )**NET
                CASH PROVIDED BY FINANCING ACTIVITIES**
            
            
            40,133
            
            
            29,268**Net
                increase in cash and cash equivalents**
            
            
            41,416
            
            
            4,389**Cash
                and cash equivalents, beginning of period**
            
            
            23,034
            
            
            44,559**Cash
                and cash equivalents, end of period**
            
            $
            64,450
            
            $
            48,948Supplemental
                disclosures of cash flow information:Interest
                paid
            
            $
            7,000
            
            $
            3,543Income
                taxes paid
            
            $
            2,030
            
            $
            2,015




See
                notes to condensed consolidated financial
                statements




-8-




**HERITAGE
      OAKS BANCORP**


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


**JUNE
      30, 2007**




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





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





The
      condensed consolidated financial statements include the accounts of the Company
      and its wholly-owned financial subsidiary, Heritage Oaks Bank (the “Bank”). All
      significant inter-company balances and transactions have been eliminated.
      Heritage Oaks Capital Trust II is an unconsolidated subsidiary formed solely
      for
      the purpose of issuing trust preferred securities. Operating results for the
      three and six months ended June 30, 2007 are not necessarily indicative of
      the
      results that may be expected for the year ending December 31, 2007. Certain
      amounts in the consolidated financial statements for the year ended December
      31,
      2006 and the three and six month period ended June 30, 2006 may have been
      reclassified to conform to the presentation of the consolidated financial
      statements in 2007.





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





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





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


-9-


The
      following table sets forth the amortized cost and fair values of investment
      securities available for sale at June 30, 2007 and December 31,
      2006:




*(dollars
                in thousands)*
            
            
            
            **Gross**
            
            **Gross****Amortized**
            
            **Unrealized**
            
            **Unrealized**
            
            **Fair****As
                of June 30, 2007**
            
            **Cost**
            
            **Gains**
            
            **Losses**
            
            **Value**Obligations
                of U.S. government agencies and corporations
            
            $
            196
            
            $
            -
            
            $
            (6
            )
            $
            190Mortgage-backed
                securities
            
            
            19,876
            
            
            8
            
            
            (401
            )
            
            19,483Obligations
                of state and political subdivisions
            
            
            16,215
            
            
            292
            
            
            (171
            )
            
            16,336Other
                securities
            
            
            9
            
            
            -
            
            
            -
            
            
            9Total
            
            $
            36,296
            
            $
            300
            
            $
            (578
            )
            $
            36,018




**Gross**
            
            **Gross****Amortized**
            
            **Unrealized**
            
            **Unrealized**
            
            **Fair****As
                of December 31, 2006**
            
            **Cost**
            
            **Gains**
            
            **Losses**
            
            **Value**Obligations
                of U.S. government agencies and corporations
            
            $
            205
            
            $
            -
            
            $
            (4
            )
            $
            201Mortgage-backed
                securities
            
            
            21,959
            
            
            16
            
            
            (381
            )
            
            21,594Obligations
                of state and political subdivisions
            
            
            16,139
            
            
            540
            
            
            (38
            )
            
            16,641Other
                securities
            
            
            9
            
            
            -
            
            
            -
            
            
            9Total
            
            $
            38,312
            
            $
            556
            
            $
            (423
            )
            $
            38,445





At
      June
      30, 2007, the securities portfolio had a net unrealized loss of approximately
      $278 thousand and $167 thousand, net of tax. This, when compared to the net
      unrealized gain of approximately $133 thousand and $80 thousand, net of tax
      the
      portfolio had at December 31, 2006 represents a decline in market value of
      approximately $411 thousand and $247 thousand, net of tax. The decline in fair
      value during 2007 can be attributed to an increase of approximately 32bp in
      the
      10 year treasury during the first half of 2007.




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





**June
                30,**
            
            **December 31,***(dollars
                in thousands)*
            
            **2007**
            
            **2006**Commercial,
                financial, and agricultural
            
            $
            98,440
            
            $
            84,976Real
                estate-construction/land
            
            
            100,998
            
            
            105,712Real
                estate - other
            
            
            245,110
            
            
            237,401Home
                equity lines of credit
            
            
            9,330
            
            
            10,792Installment
                loans to individuals
            
            
            5,711
            
            
            5,598All
                other loans (including overdrafts)
            
            
            390
            
            
            504Total
                loans, gross
            
            
            459,979
            
            
            444,983Less
                - deferred loan fees, net
            
            
            1,559
            
            
            1,625Less
                - reserve for possible loan losses
            
            
            4,520
            
            
            4,081Total
                loans, net
            
            $
            453,900
            
            $
            439,277Loans
                held for sale
            
            $
            3,329
            
            $
            1,764




*Concentration
      of Credit Risk*





At
      June
      30, 2007, approximately $355.4 million of the Bank’s loan portfolio was
      collateralized by various forms of real estate, this represents a slight
      increase of approximately $1.5 million when compared to the $353.9 million
      reported at December 31, 2006. Such loans are generally made to borrowers
      located in San Luis Obispo and Santa Barbara Counties. The Bank attempts to
      reduce its concentration of credit risk by making loans which are diversified
      by
      project type. While management believes that the collateral presently securing
      this portfolio is adequate, there can be no assurances that significant deterioration
      in the California real estate market would not expose the Bank to significantly
      greater credit risk. At June 30, 2007, the Bank was contingently liable for
      letters of credit accommodations made to its customers totaling approximately
      $16.7 million and un-disbursed loan commitments in the approximate amount of
      $173.5 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.


-10-





*Allowance
      for Loan Losses*




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





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





**For
                the three months ended**
            
            **For
                the six months ended**
            
            **For the year ended***(dollars
                in thousands)*
            
            **June
                30, 2007**
            
            **June
                30, 2006**
            
            **June
                30, 2007**
            
            **June
                30, 2006**
            
            **December 31, 2006**Balance
                at beginning of period
            
            $
            4,312
            
            $
            4,005
            
            $
            4,081
            
            $
            3,881
            
            $
            3,881Additions
                charged to operating expense
            
            
            170
            
            
            180
            
            
            310
            
            
            300
            
            
            600Loans
                charged off
            
            
            (19
            )
            
            (502
            )
            
            (20
            )
            
            (502
            )
            
            (561
            )Recoveries
                of loans previously charged off
            
            
            57
            
            
            12
            
            
            149
            
            
            16
            
            
            161Balance
                at end of period
            
            $
            4,520
            
            $
            3,695
            
            $
            4,520
            
            $
            3,695
            
            $
            4,081





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





The
      analysis of the allowance for loan losses is comprised of three components:
      specific credit allocation; general portfolio allocation; and subjectively
      by
      determined allocation. Effective January 1, 1995, the Bank adopted SFAS No.114,
      “ *Accounting
      by Creditors for Impairment of a Loan”* (SFAS
      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 effective interest rate or the fair value of the
      collateral for certain collateral dependent loans. The general portfolio
      allocation consists of an assigned reserve percentage based on the credit rating
      of the loan. The subjective portion is determined based on loan history and
      the
      Bank’s evaluation of various factors including current economic conditions and
      trends in the portfolio including delinquencies and impairment, as well as
      changes in the composition of the portfolio.





The
      allowance for loan losses is based on estimates, and ultimate losses 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
      three months ended June 30, 2007 is consistent with prior periods. The allowance
      for loan losses as a percentage of total gross loans was 0.98% as of June 30,
      2007 and 0.92% as of December 31, 2006. Management believes that the allowance
      for loan losses at June 30, 2007 is prudent and warranted, based on information
      currently available.


-11-





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





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





The
      following table shows the number of shares used to calculate and the earnings
      per share for the three and six months ending June 30, 2007:





**For the three months ending**
            
            **For the six months ending****June
                30,**
            
            **June
                30,****2007**
            
            **2006**
            
            **2007**
            
            **2006**Net
                Income
            
            $
            1,800,532
            
            $
            1,673,467
            
            $
            3,310,864
            
            $
            3,279,723Basic
            
            $
            0.28
            
            $
            0.26
            
            $
            0.52
            
            $
            0.52Diluted
            
            $
            0.27
            
            $
            0.25
            
            $
            0.50
            
            $
            0.49Shares:Basic
            
            
            6,432,687
            
            
            6,337,712
            
            
            6,408,419
            
            
            6,300,499Diluted
            
            
            6,692,467
            
            
            6,670,942
            
            
            6,684,067
            
            
            6,653,951





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





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




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





ACCOUNTING
      FOR SERVICING OF FINANCIAL ASSETS: In March 2006, the Financial Accounting
      Standards Board (FASB) issued SFAS No. 156, "Accounting for Servicing of
      Financial Assets- an amendment of FASB Statement No. 140." SFAS No.156 requires
      an entity to recognize a servicing asset or servicing liability each time it
      undertakes an obligation to service a financial asset by entering into a
      servicing contract in specific situations. Additionally, the servicing asset
      or
      servicing liability shall be initially measured at fair value; however, an
      entity may elect the "amortization method" or "fair value method" for subsequent
      balance sheet reporting periods. SFAS No.156 is effective as of an entity's
      first fiscal year beginning after September 15, 2006. The adoption of this
      statement has not had a material impact on its financial condition, results
      of
      operations or cash flows as of June 30, 2007.


-12-





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





EMPLOYERS’
      ACCOUNTING FOR DEFINED BENEFIT PENSION AND OTHER POSTRETIREMENT PLANS: In
      September 2006, the FASB issued Statement of Financial Accounting Standards
      No. 158, *Employers’
      Accounting for Defined Benefit Pension and Other Postretirement Plans (an
      amendment of FASB Statements No. 87, 88, 106, and 132R)* (SFAS
      158), requires an employer to: (a) Recognize in its statement of financial
      position an asset for a plan’s over funded status or a liability for a plan’s
      under funded status; (b) measure a plan’s assets and its obligations that
      determine its funded status as of the end of the employer’s fiscal year (with
      limited exceptions); and (c) recognize changes in the funded status of a
      defined benefit postretirement plan in the year in which the changes occur.
      Those changes will be reported in comprehensive income of a business entity
      and
      in changes in net assets of a not-for-profit organization. The requirement
      by
      SFAS 158 to recognize the funded status of a benefit plan and the disclosure
      requirements of SFAS 158 are effective as of the end of the fiscal year ending
      after December 15, 2006 for entities with publicly traded equity
      securities. The adoption of SFAS 158 has not had a material effect on the
      financial position of the company at June 30, 2007.





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




-13-




**Note
        6. SHARE-BASED COMPENSATION**
 
 As
        of
        June 30, 2007, the Company had three share-based employee compensation plans,
        which are more fully described in Note 14 of the Consolidated Financial
        Statements in the Company's Annual Report filed on Form 10-K for the year
        ended
        December 31, 2006. These plans include two stock option plans and the 2005
        Equity Based Compensation Plan.
 
 Effective
        January 1, 2006, the Company adopted the fair value recognition provisions
        of
        SFAS No. 123(R), using the modified prospective transition method and,
        therefore, have not restated results for prior periods.
 
 Prior
        to
        January 1, 2006, the Company accounted for 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". No share-based compensation
        expense was reflected in net income as all options are required by the plan
        to
        be granted with an exercise price equal to the estimated fair value of the
        underlying common stock on the date of grant.
 
 Share-based
        compensation expense for all share-based compensation awards granted after
        January 1, 2006, is based on the grant-date fair value. For all awards except
        stock option awards, the grant date fair value is either the fair market
        value
        per share or book value per share (corresponding to the type of stock awarded)
        as of the grant date. For stock option awards, the grant date fair value
        is
        estimated using the Black-Scholes option pricing model. For all awards the
        Company recognizes these compensation costs only for those shares expected
        to
        vest on a straight-line basis over the requisite service period of the award,
        for which we use the related vesting term. The Company estimates forfeiture
        rates based on historical employee option exercise and employee termination
        experience.
 
 As
        a
        result of the Company’s January 1, 2006, adoption of SFAS No.123(R), the impact
        to the Consolidated Financial Statements for the three and six months ended
        June
        30, 2007 on income before income taxes and on net after tax income were
        reductions of $92 thousand and $54 thousand and $184 thousand and $108 thousand,
        respectively. For the three and six months ended June 30, 2007, the change
        had
        no impact on basic and $.008 and $0.016 impact on diluted earnings per share,
        respectively. During the three and six months ended June 30, 2006, share-based
        compensation expense was $63 thousand and $37 thousand, net of tax and $181
        thousand and $106 thousand, net of tax, respectively. For the same periods
        ended
        in 2006, the change had no impact on basic and $0.006 and $0.016 impact on
        diluted earnings per share, respectively. 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.
 
 The
        amount of expense associated with stock option awards for the three and six
        months ended June 30, 2007, was $17 thousand and $33 thousand, net of tax,
        respectively. The amount of expense associated with stock option awards for
        the
        first six months of 2006 was $74 thousand and $47 thousand, net of tax. Because
        the Company recorded compensation expense related to stock option awards
        above
        the required amount in the first quarter of 2006, The Company did not recognize
        any expense during the second quarter of 2006.
 
 The
        share-based compensation expense recognized in the condensed consolidated
        statement of operations for the three and six months ended June 30, 2007
        and
        2006 is based on awards ultimately expected to vest, and accordingly has
        been
        adjusted by the amount of estimated forfeitures. SFAS No. 123(R) requires
        forfeitures to be estimated at the time of grant and revised, if necessary,
        in
        subsequent periods if actual forfeitures differ from those estimates.
        Forfeitures were estimated based partially on historical
        experience.
 
 The
        aggregate intrinsic value in the table below represents the total pretax
        intrinsic value (the difference between the Company’s closing stock price on the
        last trading day of the second quarter of 2007 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 June
        30,
        2007. The aggregate pretax intrinsic value is subject to change based on
        the
        fair market value of the Company's stock. Total intrinsic value of options
        exercised for the three and six months ended June 30, 2007 was $249 thousand
        and
        $1,070 thousand, respectively. The total intrinsic value of options exercised
        for the three and six month periods ended June 30, 2006, was $184 thousand
        and
        $703 thousand, respectively. No options were granted during the three and
        six
        month periods ended June 30, 2007 or in the entirety of 2006.
  -
            14
            -
  The
        following table provides a summary of the aggregate intrinsic value of options
        outstanding and exercisable as well as options granted, exercised, and forfeited
        during the year-to-date period ended June 30, 2007:
 
 **Number
                  of**
                **Shares**
              
              **Weighted**
                **Average**
                **Exercise**
                **Price**
              
              **Average**
                **Remaining**
                **Contractual**
                **Term**
                **(in
                  years)**
              
              **Total**
                **Intrinsic**
                **Value**
                **(in
                  000's)**Options
                  outstanding, January 1, 2007
              
              
              436,567
              
              $
              5.43Granted
              
              
              -
              
              
              -Exercised
              
              
              (129,764
              )
              
              2.97Forfeited
              
              
              (997
              )
              
              10.77Options
                  outstanding, June 30, 2007
              
              
              305,806
              
              $
              6.46
              
              
              4.24
              
              $
              3,545Exercisable
                  at June 30, 2007
              
              
              264,029
              
              $
              5.71
              
              
              3.82
              
              $
              3,257Options
                  outstanding, January 1, 2006
              
              
              525,916
              
              $
              5.19Granted
              
              
              -
              
              
              -Exercised
              
              
              (46,162
              )
              
              3.54Forfeited
              
              
              (2
              )
              
              4.36Options
                  outstanding, June 30, 2006
              
              
              479,752
              
              $
              5.35
              
              
              4.10
              
              $
              5,351Exercisable
                  at June 30, 2006
              
              
              410,661
              
              $
              4.45
              
              
              3.70
              
              $
              4,948
  As
        of
        June 30, 2007, there was a total of $171 thousand of total unrecognized
        compensation expense related to non-vested share-based compensation
        arrangements. That expense is expected to be recognized over a weighted-average
        period of 1.15 years.
 
 The
        Company grants restricted share awards periodically for the benefit of
        employees. These restricted shares generally “cliff vest” after five years of
        issuance. Recipients of restricted shares have the right to vote all shares
        subject to such grant, and receive all dividends with respect to such shares,
        whether or not the shares have vested. Recipients do not pay any cash
        consideration for the shares. For the three and six months ended June 30,
        2007,
        the Company recorded compensation expense related to restricted share awards
        of
        $37 thousand and $75 thousand, net of tax, respectively. The total unrecognized
        compensation expense related to restricted share awards as of June 30, 2007
        is
        $921 thousand or $542 thousand, net of tax. The remaining amount of compensation
        expense related to restricted share awards at June 30, 2007 is expected to
        recognized over the next 3.62 years. For the three and six months ended June
        30,
        2006, the Company recorded compensation expense related to restricted share
        awards in the amounts of $37 thousand and $62 thousand, net of tax,
        respectively. At June 30, 2006, there was a total of $1,163 thousand or $684
        thousand, net of tax in unrecognized expense related to restricted share
        awards.
  -
            15
            -
 
 **Note
        7.**  **RECLASSIFICATIONS**
 
 Certain
        amounts in the 2006 financial statements have been reclassified to conform
        to
        the 2007 presentation.
  **Forward
        Looking Statements**
 
 **Certain
        statements contained in this Quarterly Report on Form 10-Q (“Quarterly Report”),
        including, without limitation, statements containing the words “believes”,
“anticipates”, “intends”, “expects”, and words of similar impact, constitute
“forward-looking statements” within the meaning of Section 27A of the Securities
        Act of 1933 and Section 21E of the Securities and Exchange Act of 1934. Such
        forward-looking statements involve known and unknown risks, uncertainties
        and
        other factors that may cause the actual results, performance or achievements
        of
        the Company to be materially different from any future results, performance
        or
        achievements expressed or implied by such forward-looking statements. Such
        factors include, among others, the following: general economic and business
        conditions in those areas in which the Company operates, demographic changes,
        competition, fluctuations in interest rates, changes in business strategy
        or
        development plans, changes in governmental regulation, credit quality, the
        availability of capital to fund the expansion of the Company’s business, as well
        as economic, political and global changes arising from the war on terrorism.
        (Refer to the Company’s December 31, 2006 10-K, ITEM 1A. Risk Factors.) The
        Company disclaims any obligation to update any such factors or to publicly
        announce the results of any revisions to any of the forward-looking statements
        contained herein to reflect future events or developments.**
 
 -
            16
            -
 
 **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 June 30, 2007 and 2006. The analysis should
        be read in connection with the consolidated financial statements and notes
        thereto appearing elsewhere in this report.
 
 THE
        COMPANY
 
 Heritage
        Oaks Bancorp (the "Company") is a California corporation organized in 1994
        to
        act as a holding company of Heritage Oaks Bank ("Bank"), a 12 branch bank
        serving San Luis Obispo and northern Santa Barbara Counties. In 1994, the
        Company acquired all of the outstanding common stock of the Bank in a holding
        company formation transaction.
 
 In
        April
        2002, the Company formed Heritage Oaks Capital Trust I (the “Trust”). The Trust
        is a statutory business trust formed under the laws of the State of Delaware.
        The Trust is a wholly-owned, non-financial, non-consolidated subsidiary of
        the
        Company. On April 23, 2007 the Company redeemed all of the Floating Rate
        Junior
        Subordinated Debt Securities it held associated with Heritage Oaks Capital
        Trust
        I, a wholly-owned subsidiary of Heritage Oaks Bancorp. As a result of the
        redemption of these securities, the Trust was dissolved on June 1,
        2007.
 
 In
        October 2006, the Company formed Heritage Oaks Capital Trust II (the “Trust”).
        The Trust is a statutory business trust formed under the laws of the State
        of
        Delaware. The Trust is a wholly-owned, non-financial, non-consolidated
        subsidiary of the Company.
 
 Other
        than holding the shares of the Bank, the Company conducts no significant
        activities, although it is authorized, with the prior approval of the Board
        of
        Governors of the Federal Reserve System (the "Federal Reserve Board"), the
        Company's principal regulator, to engage in a variety of activities which
        are
        deemed closely related to the business of banking. The Company has also caused
        to be incorporated a subsidiary, CCMS Systems, Inc. which is currently inactive
        and has not been capitalized. The Company has no present plans to activate
        the
        proposed subsidiary.
 
 *Where
        You Can Find More Information*
 
 Under
        the
        Securities Exchange Act of 1934 Sections 13 and 15(d), periodic and current
        reports must be filed with the SEC. The Company electronically files the
        following reports with the SEC: Form 10-K (Annual Report), Form 10-Q (Quarterly
        Report), Form 8-K (Current Report), and Form DEF 14A (Proxy Statement). The
        Company may file additional forms. The SEC maintains an internet site,
        www.sec.gov, in which all forms filed electronically may be accessed.
        Additionally, all forms filed with the SEC and additional shareholder
        information is available free of charge on the Company’s website:
        www.heritageoaksbancorp.com
 
 The
        Company posts these reports to its website as soon as reasonably practicable
        after filing them with the SEC. None of the information on or hyperlinked
        from
        the Company’s website is incorporated into this Quarterly Report on Form
        10-Q.
 
 -
            17
            -
 
 **EXECUTIVE
        SUMMARY AND RECENT DEVELOPMENTS**
 
 *Earnings
        and Financial Condition Overview*
 
 For
        the
        three months ended June 30, 2006, the Company earned $1.8 million or $0.27
        per
        diluted share. This, when compared to the $1.7 million or $0.25 per diluted
        share the Company earned in the year ago period, represents an approximate
        7.6%
        increase in net income. For the first six months of 2007 the Company earned
        $3.3
        million or $0.50 per diluted share. This represents an approximate 1.0% increase
        in net income when compared to the $3.3 million or $0.49 per diluted share
        the
        Company earned in the first six months of 2006. The increase in net income
        for
        the current and year to date periods can be attributed to an approximate
        25.0%
        increase in interest income for both periods respectively. The increase in
        interest income is mainly due to the continued strength the Bank has seen
        in the
        loan portfolio when compared to the same period last year as well as a rise
        in
        interest rates during 2007.
 
 Interest
        expense for the current and year to date periods totaled $3.6 million and
        $6.8
        million respectively. This represents approximate increases of $1.5 million
        and
        $3.0 million for both the three and six month periods ended June 30, 2007
        when
        compared to the same periods ended in 2006. The increase in interest expense
        is
        mainly attributable to the strong deposit growth the Bank has experienced
        during
        2007.
 
 Non-interest
        expenses for the three and six month periods ended June 30, 2007 were $5.6
        million and $11.3 million respectively. This represents approximate increases
        of
        10.2% and 12.2% over the same periods ended in 2006. Increases in non-interest
        expenses can be attributed in part to higher professional fees and outside
        services, increased salaries and employee benefits related to the addition
        of a
        new full service branch in the town of Templeton, as well as additional
        advertising and promotional costs related to current promotions designed
        to
        attract core deposits.
 
 Increases
        in interest income helped contribute to a notable decline in the Company’s
        efficiency ratio when compared to the first quarter. For the three months
        ended
        June 30, 2007 the efficiency ratio was 64.32% compared to 68.89% for the
        first
        three months of the year and 64.34% for the three months ended June 30, 2006.
        For the first half of 2007 and 2006 the efficiency ratio was 66.55% and 64.67%
        respectively.
 
 Return
        on
        average equity for the three and six month periods ended June 30, 2007 was
        13.84% and 12.99% respectively. This was down slightly from 14.37% and 14.25%
        for the same periods ended in 2006.
 
 As
        of
        June 30, 2007, total assets were $589.9 million. This represents an 8.9%
        increase from the $541.8 million the Company reported at the end of 2006.
        The
        growth in total assets can be attributed to a $14.6 million increase in net
        loan
        balances as well as a $39.6 million increase in federal funds sold. The
        significant rise in federal funds sold can be attributed to significant
        increases in deposit balances during the first six months of the year. At
        June
        30, 2007, total deposits were $489.1 million. This represents an increase
        of
        approximately $68.6 million or 16.3% over the $420.5 million the company
        reported at December 31, 2006. The growth in deposit balances can be attributed
        to a $35.7 million or 46.0% increase in money market accounts, which is the
        result of current promotions the Company rolled out in the first quarter
        to
        attract core deposits. Interest bearing demand and time deposit balances
        also
        contributed significantly to the rise in total deposits, adding $12.1 million
        and $20.5 million respectively when compared to the year ended December 31,
        2006. The significant rise in total deposits has not only contributed to
        the
        rise in federal funds sold, but has also allowed the Bank to pay down higher
        cost Federal Home Loan Bank (“FHLB”) borrowings by $20.0 million during the
        first six months of 2007. FHLB borrowings were $30.0 million at June 30,
        2007
        compared to $50.0 million at December 31, 2006.
 
 *Recent
        Developments*
 
 On
        May
        29, 2007 the Company announced that it had entered into an Agreement to Merge
        and Plan of Reorganization with Business First National Bank (“Business First”).
        Under the terms of the agreement, Business First will be acquired by Heritage
        Oaks Bancorp (“Heritage”) and merged into Heritage Oaks Bank, a wholly owned
        subsidiary of Heritage. Under the terms of the agreement and based on Heritage’s
        closing stock price as of May 29, 2007, Heritage will pay approximately $20.6
        million for Business First, consisting of approximately 75% Heritage common
        stock and 25% cash. Pursuant to the terms of the agreement, Business First
        shareholders will receive 0.5758 shares of Heritage common stock for each
        share
        of Business First they own and $3.44 in cash. The merger is subject to the
        approval of Business First shareholders, applicable banking regulators, and
        other customary closing conditions. The transaction is expected to close
        in the
        fourth quarter of this year. Business First is located in Santa Barbara,
        California with two branches and had assets totaling approximately $154.4
        million as of June 30, 2007.
 
 -
            18
            -
 
 On
        April
        23, 2007 the Company redeemed all of the Floating Rate Junior Subordinated
        Debt
        Securities it held associated with Heritage Oaks Capital Trust I, a wholly-owned
        subsidiary of Heritage Oaks Bancorp. The redemption price was 100% of the
        principal amount redeemed plus accrued and unpaid interest as of the Redemption
        Date. The Company paid $379,011 for the standard interest payment due April
        22,
        2007, plus a payment of $8,248,000 for the principal amount to be redeemed
        on
        that date. These amounts were funded from the Company’s general corporate
        reserves. As a result of the redemption of the securities the Company held
        associated with Heritage Oaks Capital Trust I, the Trust was dissolved on
        June
        1, 2007.
 
 On
        May
        11, 2007 the Company entered into a material definitive agreement to sell
        four
        of the Bank’s properties to First States Group, L.P. (“First States”) in a
        sale/leaseback transaction for $12,810,000. In connection with the sale,
        the
        Bank entered into a separate lease agreement with First States Investors,
        LLC to
        lease back three branches and one administrative facility under which the
        bank
        will continue to utilize the properties for the normal course of business.
        The
        three branches are located in Paso Robles, Arroyo Grande and Santa Maria,
        California. The administrative facility is located in Paso Robles, California.
        The initial annual base rents for the Paso Robles, Arroyo Grande, and Santa
        Maria branches are $198,594, $92,456, and $150,920 respectively. The initial
        annual base rent for the administrative facility is $454,730. Each of the
        four
        leases contain an annual rent escalation clause equal to the lower of CPI-U
        (Consumer Price Index for all Urban Consumers) or 2.5 percent, commencing
        in the
        second year of the lease term. Each of the four leases provide for an initial
        term of 15 years with the option to renew for two 10 year terms.
 
 In
        connection with the sale of the properties mentioned, the Bank will recognize
        a
        gain of approximately $3.4 million. This gain will be amortized over a fifteen
        year period in accordance with sale-leaseback accounting rules. The gain
        had no
        impact on the Company’s results of operations for the three and six months ended
        June 30, 2007. However, in addition to deferring the gain on sale, the Company
        has recorded an income tax liability and a deferred tax asset in the approximate
        amounts of $1.3 million, directly related to the deferred gain on sale.
 
 The
        following table provides a brief summary of the gain the Bank will recognize
        in
        connection with the sale of the properties previously mentioned:
 
 Aggregate
                  purchase price
              
              $
              12,809,999Net
                  book value of properties sold
              
              
              9,401,087Gain
                  on sale
              
              
              3,408,912Yearly
                  amortization of gain
              
              $
              227,261
 
 The
        Company is currently exploring the best use for the funds received in connection
        with the sale.
 
 On
        July
        18, 2007, the Board of Directors authorized a one year extension of the stock
        repurchase program that was adopted in July 2006. Under the one year extension
        the Company may repurchase up to 100,000 shares of its common stock, of which
        40,000 shares have already been repurchased under the current plan.
 
 On
        July
        18, 2007, the Board of Directors declared a quarterly cash dividend of $0.08
        per
        share to be paid on August 17, 2007 to shareholders of record on August 3,
        2007.
 
 On
        April
        20, 2007, the Board of Directors declared a quarterly cash dividend of $0.08
        per
        share to be paid on May 18, 2007 to shareholders of record on May 4, 2007.
  On
        January 19, 2007, the Board of Directors declared a quarterly cash dividend
        of
        $0.08 per share to be paid on February 16, 2007 to shareholders of record
        on
        February 2, 2007.
 
 -
            19
            -
 
 *Selected
        Financial Data*
 
 The
        table
        below provides selected financial data that highlights the Company’s quarterly
        performance results:
  *(dollars
                  in thousands except share data)***For
                  the quarters ended****06/30/07**
              
              **03/31/07**
              
              **12/31/06**
              
              **09/30/06**
              
              **06/30/06**
              
              **03/31/06**
              
              **12/31/05**
              
              **09/30/05**Return
                  on average assets
              
              
              1.25
              %
              
              1.10
              %
              
              1.24
              %
              
              1.35
              %
              
              1.38
              %
              
              1.33
              %
              
              1.47
              %
              
              1.44
              %Return
                  on average equity
              
              
              13.84
              %
              
              12.10
              %
              
              13.64
              %
              
              14.54
              %
              
              14.37
              %
              
              13.92
              %
              
              16.38
              %
              
              17.03
              %Average
                  equity to average assets
              
              
              9.02
              %
              
              9.07
              %
              
              9.11
              %
              
              9.25
              %
              
              9.59
              %
              
              9.58
              %
              
              8.97
              %
              
              8.47
              %Net
                  interest margin
              
              
              5.56
              %
              
              5.66
              %
              
              5.77
              %
              
              6.07
              %
              
              6.06
              %
              
              5.98
              %
              
              6.06
              %
              
              5.80
              %Efficiency
                  ratio*
              
              
              64.32
              %
              
              68.89
              %
              
              67.12
              %
              
              65.31
              %
              
              64.34
              %
              
              65.02
              %
              
              60.65
              %
              
              61.08
              %Average
                  loans to average deposits
              
              
              103.52
              %
              
              108.23
              %
              
              105.03
              %
              
              97.15
              %
              
              94.37
              %
              
              90.15
              %
              
              89.84
              %
              
              89.60
              %Net
                  Income
              
              $
              1,800
              
              $
              1,510
              
              $
              1,649
              
              $
              1,733
              
              $
              1,673
              
              $
              1,606
              
              $
              1,808
              
              $
              1,805Earnings
                  Per Share:Basic
              
              $
              0.28
              
              $
              0.24
              
              $
              0.26
              
              $
              0.27
              
              $
              0.26
              
              $
              0.26
              
              $
              0.29
              
              $
              0.29Diluted
              
              $
              0.27
              
              $
              0.23
              
              $
              0.25
              
              $
              0.26
              
              $
              0.25
              
              $
              0.24
              
              $
              0.27
              
              $
              0.28Outstanding
                  Shares:Basic
              
              
              6,432,687
              
              
              6,384,150
              
              
              6,355,466
              
              
              6,350,727
              
              
              6,337,712
              
              
              6,283,890
              
              
              6,223,500
              
              
              6,186,045Diluted
              
              
              6,692,467
              
              
              6,605,942
              
              
              6,598,355
              
              
              6,594,626
              
              
              6,670,942
              
              
              6,643,432
              
              
              6,592,000
              
              
              6,499,178
 *
        The
        efficiency ratio is defined as total non-interest expense as a percent of
        the
        combined net interest income plus non-interest income.
 
 The
        Company’s earnings are highly influenced by changes in short term interest
        rates. The nature of the Company’s balance sheet can be summarily described as
        of short duration and asset sensitive. The balance sheet is of short duration
        because a large percentage of its interest sensitive assets and liabilities
        re-price immediately with changes in the Federal Funds and Prime interest
        rates.
        The Company is asset sensitive, primarily due to its large volume of
        non-interest bearing demand deposit accounts which effectively never re-price.
        Therefore, an upward movement in short term interest rates will generally
        result
        in higher net interest margin and, conversely, a reduction in short term
        interest rates will result in reduced net interest margin.
 
 Historically,
        the largest and most variable source of income for the Company is net interest
        income. The results of operations for the three and six months ended June
        30,
        2007 and June 30, 2006 reflect the impact of increases in short term rates
        as
        well as growth in the volume of both interest earning assets and interest
        bearing liabilities during these periods.
 
 *Local
        Economy*
 
 The
        economy in the Company’s service area is based primarily on agriculture,
        tourism, light industry, oil and retail trade. Services supporting these
        industries have also developed in the areas of medical, financial and
        educational services. The population of San Luis Obispo County and the City
        of
        Santa Maria (in Northern Santa Barbara County) in 2005 **** totaled
        approximately 260,000 and 90,000, respectively, according to economic data
        provided by local county and title company sources. The moderate climate
        allows
        a year round growing season for numerous vegetables and fruits. Vineyards
        and
        cattle ranches also contribute largely to the local economy. The Central
        Coast’s
        leading agricultural industry is the production of high quality wine grapes
        and
        production of premium quality wines. Vineyards in production have grown
        significantly over the past several years throughout the Company’s service area.
        Access to numerous recreational activities, including lakes, mountains and
        beaches, provide a relatively stable tourist industry from many areas including
        the Los Angeles/Orange County basin, the San Francisco Bay area and the San
        Joaquin Valley. Principally due to the diversity of the various industries
        in
        the Company’s service area, the area, while not immune from economic
        fluctuations, does tend to enjoy a more stable level of economic activity
        than
        many other areas of California.
 
 -
            20
            -
 
 *Critical
        Accounting Policies*
 
 The
        Company’s significant accounting policies are set forth in the 2006 Annual
        Report, Note 1 of the NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, which was
        filed on Form 10-K.
 
 The
        following is a brief description of the Company’s current accounting policies
        involving significant management valuation judgments.
 
 *Allowance
        for Loan and Lease Losses*
 
 The
        Company considers its policy regarding the allowance for loan losses to be
        its
        most critical accounting policy, because it requires management's most
        subjective and complex judgments. In addition, changes in economic conditions
        can have a significant impact on the allowance for loan losses and therefore
        the
        provision for loan losses and results of operations. The Company has developed
        appropriate policies and procedures for assessing the adequacy of the allowance
        for loan losses, recognizing that this process requires a number of assumptions
        and estimates with respect to its loan portfolio. The Company's assessments
        may
        be impacted in future periods by changes in economic conditions, the impact
        of
        regulatory examinations, and the discovery of information with respect to
        borrowers, which is not known to management at the time of the issuance of
        the
        consolidated financial statements.
 
 The
        allowance for loan and lease losses represents management’s best estimate of
        losses inherent in the existing loan portfolio. The allowance for loan and
        lease
        losses is increased by the provision for loan and lease losses charged to
        expense and reduced by loans charged-off, net of recoveries. The allowance
        for
        loan and lease losses is determined based on management’s assessment of several
        factors: reviews and evaluation of individual loans, changes in the nature
        and
        volume of the loan portfolio, current economic conditions and the related
        impact
        on specific borrowers and industry groups, historical loan loss experiences
        and
        the level of classified and nonperforming loans.
 
 Loans
        are
        considered impaired if, based on current information and events, it is probable
        that we will be unable to collect the scheduled payments of principal or
        interest when due according to the contractual terms of the loan agreement.
        The
        measurement of impaired loans is generally based on the present value of
        expected future cash flows discounted at the historical effective interest
        rate
        stipulated in the loan agreement, except that all collateral-dependent loans
        are
        measured for impairment based on the fair value of the collateral. In measuring
        the fair value of the collateral, management uses assumptions and methodologies
        consistent with those that would be utilized by unrelated third parties.
        Changes
        in the financial condition of individual borrowers, economic conditions,
        historical loss experience and the condition of the various markets in which
        collateral may be sold may all affect the required level of the allowance
        for
        loan and lease losses and the associated provision for loan and lease losses.
 
 See
        Note
        3 to the Consolidated Financial Statements for further discussion on Allowance
        for Loan Losses.
 
 *Securities
        Available for Sale*
 
 The
        fair
        values of most securities that are designated available for sale are based
        on
        quoted market prices. If quoted market prices are not available, fair values
        are
        extrapolated from the quoted prices of similar instruments.
 
 *Goodwill
        and Other Intangible Assets*
 
 As
        discussed in the 2006 Annual Report, Note 1 of the NOTES TO CONSOLIDATED
        FINANCIAL STATEMENTS, which was filed on Form 10-K, we assess goodwill and
        other
        intangible assets each year for impairment. This assessment involves a “carrying
        amount comparison” that compares the fair value of the reporting unit to its
        carrying value (stated shareholders’ equity, including goodwill).. If the
        carrying value of a reporting unit materially exceeds its fair value, the
        Company would be required to take a charge against earnings to write down
        the
        assets to the lower value. The Company determined that there was no impairment
        at December 31, 2006.
 
 -
            21
            -
 
 **RESULTS
        OF OPERATIONS**
 
 *Net
        Interest Income and Interest Margin*
 
 Net
        interest income, the primary component of the net earnings of a financial
        institution, refers to the difference between the interest paid on deposits
        and
        borrowings, and the interest earned on loans and investments. The net interest
        margin is the amount of net interest income expressed as a percentage of
        average
        earning assets. Factors considered in the analysis of net interest income
        are
        the composition and volume of earning assets and interest-bearing liabilities,
        the amount of non-interest bearing liabilities and non-accrual loans, and
        changes in market interest rates.
 
 The
        volume and rate variances table below sets forth the dollar difference in
        interest earned and paid for each major category of interest-earning assets
        and
        interest-bearing liabilities for the three and six month periods ended June
        30,
        2007, and the amount of such change attributable to changes in average balances
        (volume) or changes in average interest rates.
 
 *(dollars
                  in thousands)*
              
              **For
                  the three months ended**
                **June
                  30, 2007 over 2006**
              
              **For
                  the six months ended**
                **June
                  30, 2007 over 2006****Volume**
              
              **Rate**
              
              **Total**
              
              **Volume**
              
              **Rate**
              
              **Total****Interest
                  income:**Loans
                  (1)
              
              $
              1,887
              
              $
              309
              
              $
              2,196
              
              $
              3,805
              
              $
              717
              
              $
              4,522Investment
                  securities taxable
              
              
              (53
              )
              
              9
              
              
              (44
              )
              
              (124
              )
              
              37
              
              
              (87
              )Investment
                  securities non-taxable (2):
              
              
              3
              
              
              (5
              )
              
              (2
              )
              
              18
              
              
              (8
              )
              
              10Taxable
                  equivalent adjustment (2):
              
              
              (1
              )
              
              2
              
              
              1
              
              
              (6
              )
              
              3
              
              
              (3
              )Interest-bearing
                  deposits
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              1
              
              
              1Federal
                  funds sold
              
              
              14
              
              
              (8
              )
              
              6
              
              
              (207
              )
              
              17
              
              
              (190
              )Net
                  increase (decrease)
              
              
              1,850
              
              
              307
              
              
              2,157
              
              
              3,486
              
              
              767
              
              
              4,253**Interest
                  expense:**Savings,
                  now, money market
              
              
              72
              
              
              342
              
              
              414
              
              
              16
              
              
              498
              
              
              514Time
                  deposits
              
              
              440
              
              
              174
              
              
              614
              
              
              820
              
              
              383
              
              
              1,203Other
                  borrowings
              
              
              465
              
              
              33
              
              
              498
              
              
              1,093
              
              
              61
              
              
              1,154Long
                  term borrowings
              
              
              23
              
              
              (15
              )
              
              8
              
              
              198
              
              
              (25
              )
              
              173Net
                  increase (decrease)
              
              
              1,000
              
              
              534
              
              
              1,534
              
              
              2,127
              
              
              917
              
              
              3,044Total
                  net increase (decrease)
              
              $
              850
              
              $
              (227
              )
              $
              623
              
              $
              1,359
              
              $
              (150
              )
              $
              1,209
 
 (1)
              Loan
                  fees of $353 and $307 for the three months ending June 30, 2007
                  and 2006
                  respectively and $641 and $657 for the six months ending June 30,
                  2007 and
                  2006 respectively have been included in interest income
                  computation.
 (2)
              Adjusted
                  to a fully taxable equivalent basis using a tax rate of
                  34%.
 
 -
            22
            -
 
 The
        tables below set forth the average balance sheet information, interest income
        and expense, average yields and rates and net interest income and margin
        for the
        three and six months ended June 30, 2007 and June 30, 2006. The average balance
        of non-accruing loans has been included in loan totals.
  *(dollars
                  in thousands)*
              
              **For
                  the three months ending**
                **June
                  30, 2007**
              
              **For
                  the three months ending**
                **June
                  30, 2006****Balance**
              
              **Rate
                  (4)**
              
              **Income/Expense**
              
              **Balance**
              
              **Rate
                  (4)**
              
              **Income/Expense**Interest
                  Earning Assets:Investments
                  with other banks
              
              **$**
              **318**
              
              
              **2.52**
              **%**
              **$**
              **2**
              
              $
              318
              
              
              2.52
              %
              $
              2Investment
                  securities taxable
              
              
              **23,636**
              
              
              **4.53**
              **%**
              
              **267**
              
              
              28,309
              
              
              4.41
              %
              
              311Investment
                  securities non-taxable
              
              
              **16,621**
              
              
              **4.30**
              **%**
              
              **178**
              
              
              16,446
              
              
              4.37
              %
              
              179Federal
                  funds sold
              
              
              **13,198**
              
              
              **4.92**
              **%**
              
              **162**
              
              
              11,791
              
              
              5.31
              %
              
              156Loans
                  (1) (2)
              
              
              **469,719**
              
              
              **8.72**
              **%**
              
              **10,214**
              
              
              382,470
              
              
              8.41
              %
              
              8,018Total
                  interest earning assets
              
              
              **523,492**
              
              
              **8.29**
              **%**
              
              **10,823**
              
              
              439,334
              
              
              7.91
              %
              
              8,666Allowance
                  for possible loan losses
              
              
              **(4,417**
              **)**
              
              
              
              
              
              
              
              (4,077
              )Other
                  assets
              
              
              **59,619**
              
              
              
              
              
              
              
              
              51,573TOTAL
                  ASSETS
              
              **$**
              **578,694**
              
              
              
              
              
              
              
              $
              486,830Interest
                  Bearing Liabilities:Savings/NOW/money
                  market
              
              
              **181,654**
              
              
              **2.23**
              **%**
              
              **1,012**
              
              
              163,633
              
              
              1.47
              %
              
              598Time
                  deposits
              
              
              **133,377**
              
              
              **4.74**
              **%**
              
              **1,577**
              
              
              94,605
              
              
              4.08
              %
              
              963Other
                  borrowings
              
              
              **55,607**
              
              
              **5.55**
              **%**
              
              **769**
              
              
              22,652
              
              
              5.01
              %
              
              283Federal
                  funds purchased
              
              
              **1,130**
              
              
              **5.68**
              **%**
              
              **16**
              
              
              257
              
              
              6.24
              %
              
              4Long-term
                  debt
              
              
              **10,242**
              
              
              **7.48**
              **%**
              
              **191**
              
              
              8,248
              
              
              8.90
              %
              
              183Total
                  interest-bearing liabilities
              
              
              **382,010**
              
              
              **3.74**
              **%**
              
              **3,565**
              
              
              289,395
              
              
              2.81
              %
              
              2,031Demand
                  deposits
              
              
              **138,696**
              
              
              
              
              
              
              
              
              147,058Other
                  liabilities
              
              
              **5,818**
              
              
              
              
              
              
              
              
              3,683Stockholders'
                  Equity:Common
                  stock
              
              
              **29,833**
              
              
              
              
              
              
              
              
              29,577Additional
                  paid in capital
              
              
              **467**
              
              
              
              
              
              
              
              
              -Retained
                  earnings
              
              
              **21,801**
              
              
              
              
              
              
              
              
              17,424Valuation
                  allowance investments
              
              
              **69**
              
              
              
              
              
              
              
              
              (307
              )Total
                  stockholders' equity
              
              
              **52,170**
              
              
              
              
              
              
              
              
              46,694TOTAL
                  LIABILITIES AND STOCKHOLDERS' EQUITY
              
              **$**
              **578,694**
              
              
              
              
              
              
              
              $
              486,830Net
                  Interest Income
              
              
              
              
              
              
              
              **$**
              **7,258**
              
              
              
              
              
              
              
              $
              6,635Net
                  Interest Margin (3)
              
              
              
              
              
              **5.56**
              **%**
              
              
              
              
              
              
              
              6.06
              %
 
 (1)
              Nonaccrual
                  loans have been included in total
                  loans.
 (2)
              Loan
                  fees of $353 and $307 for the three months ending June 30, 2007
                  and 2006,
                  respectively have been included in interest income
                  computation.
 (3)
              Net
                  interest margin has been calculated by dividing the net interest
                  income by
                  total average earning assets.
 (4)
              Rate
                  is annualized using actual number of days in
                  period.
 
 -
            23
            -
 
 *(dollars
                  in thousands)*
              
              **For
                  the six months ending**
                **June
                  30, 2007**
              
              **For
                  the six months ending**
                **June
                  30, 2006****Balance**
              
              **Rate
                  (4)**
              
              **Income/Expense**
              
              **Balance**
              
              **Rate
                  (4)**
              
              **Income/Expense**Interest
                  Earning Assets:Investments
                  with other banks
              
              **$**
              **318**
              
              
              **3.17**
              **%**
              **$**
              **5**
              
              $
              312
              
              
              2.59
              %
              $
              4Investment
                  securities taxable
              
              
              **23,924**
              
              
              **4.58**
              **%**
              
              **543**
              
              
              29,250
              
              
              4.34
              %
              
              630Investment
                  securities non-taxable
              
              
              **16,636**
              
              
              **4.30**
              **%**
              
              **355**
              
              
              16,078
              
              
              4.36
              %
              
              348Federal
                  funds sold
              
              
              **7,834**
              
              
              **4.97**
              **%**
              
              **193**
              
              
              16,195
              
              
              4.77
              %
              
              383Loans
                  (1) (2)
              
              
              **465,297**
              
              
              **8.68**
              **%**
              
              **20,029**
              
              
              376,308
              
              
              8.31
              %
              
              15,507Total
                  interest earning assets
              
              
              **514,009**
              
              
              **8.29**
              **%**
              
              **21,125**
              
              
              438,143
              
              
              7.77
              %
              
              16,872Allowance
                  for possible loan losses
              
              
              **(4,299**
              **)**
              
              
              
              
              
              
              
              (4,010
              )Other
                  assets
              
              
              **58,630**
              
              
              
              
              
              
              
              
              50,299TOTAL
                  ASSETS
              
              **$**
              **568,340**
              
              
              
              
              
              
              
              $
              484,432Interest
                  Bearing Liabilities:Savings/NOW/money
                  market
              
              
              **170,263**
              
              
              **2.05**
              **%**
              
              **1,731**
              
              
              168,064
              
              
              1.46
              %
              
              1,217Time
                  deposits
              
              
              **129,695**
              
              
              **4.66**
              **%**
              
              **2,998**
              
              
              92,301
              
              
              3.92
              %
              
              1,795Other
                  borrowings
              
              
              **56,420**
              
              
              **5.44**
              **%**
              
              **1,521**
              
              
              17,688
              
              
              4.82
              %
              
              423Federal
                  funds purchased
              
              
              **2,123**
              
              
              **5.70**
              **%**
              
              **60**
              
              
              129
              
              
              6.25
              %
              
              4Long-term
                  debt
              
              
              **13,352**
              
              
              **7.91**
              **%**
              
              **524**
              
              
              8,248
              
              
              8.58
              %
              
              351Total
                  interest-bearing liabilities
              
              
              **371,853**
              
              
              **3.71**
              **%**
              
              **6,834**
              
              
              286,430
              
              
              2.67
              %
              
              3,790Demand
                  deposits
              
              
              **139,878**
              
              
              
              
              
              
              
              
              147,642Other
                  liabilities
              
              
              **5,218**
              
              
              
              
              
              
              
              
              3,941Stockholders'
                  Equity:Common
                  stock
              
              
              **29,587**
              
              
              
              
              
              
              
              
              29,465Additional
                  paid in capital
              
              
              **419**
              
              
              
              
              
              
              
              
              -Retained
                  earnings
              
              
              **21,316**
              
              
              
              
              
              
              
              
              17,159Valuation
                  allowance investments
              
              
              **69**
              
              
              
              
              
              
              
              
              (205
              )Total
                  stockholders' equity
              
              
              **51,391**
              
              
              
              
              
              
              
              
              46,419TOTAL
                  LIABILITIES AND STOCKHOLDERS' EQUITY
              
              **$**
              **568,340**
              
              
              
              
              
              
              
              $
              484,432Net
                  Interest Income
              
              
              
              
              
              
              
              **$**
              **14,291**
              
              
              
              
              
              
              
              $
              13,082Net
                  Interest Margin (3)
              
              
              
              
              
              **5.61**
              **%**
              
              
              
              
              
              
              
              6.02
              %
 
 (1)
              Nonaccrual
                  loans have been included in total
                  loans.
 (2)
              Loan
                  fees of $641 and $657 for the six months ending June 30, 2007 and
                  2006,
                  respectively have been included in interest income
                  computation.
 (3)
              Net
                  interest margin has been calculated by dividing the net interest
                  income by
                  total average earning assets.
 (4)
              Rate
                  is annualized using actual number of days in
                  period.
 
 -
            24
            -
 
 The
        tables below set forth changes for the three and six months ending June 30,
        2007
        compared to the same periods in 2006 for average interest earning assets
        and
        their respective average yields.
 
 *(dollars
                  in thousands)*
              
              **Average
                  Balance**
                **for
                  the three months ending**
                **June
                  30,**
              
              **Variance**
              
              **Average
                  Yield**
                **for
                  the three months ending**
                **June
                  30,****2007**
              
              **2006**
              
              **dollar**
              
              **percentage**
              
              **2007**
              
              **2006**
              
              **Variance**Interest
                Earning Assets:Time
                  deposits with other banks
              
              $
              318
              
              $
              318
              
              $
              -
              
              
              0.00
              %
              
              2.52
              %
              
              2.52
              %
              
              0.00
              %Investment
                  securities taxable
              
              
              23,636
              
              
              28,309
              
              
              (4,673
              )
              
              -16.51
              %
              
              4.53
              %
              
              4.41
              %
              
              0.12
              %Investment
                  securities non-taxable
              
              
              16,621
              
              
              16,446
              
              
              175
              
              
              1.06
              %
              
              4.30
              %
              
              4.37
              %
              
              -0.07
              %Federal
                  funds sold
              
              
              13,198
              
              
              11,791
              
              
              1,407
              
              
              11.93
              %
              
              4.92
              %
              
              5.31
              %
              
              -0.39
              %Loans
                  (1) (2)
              
              
              469,719
              
              
              382,470
              
              
              87,249
              
              
              22.81
              %
              
              8.72
              %
              
              8.41
              %
              
              0.31
              %Total
                  interest earning assets
              
              $
              523,492
              
              $
              439,334
              
              $
              84,158
              
              
              19.16
              %
              
              8.29
              %
              
              7.91
              %
              
              0.38
              %
 
 (1)
              Nonaccrual
                  loans have been included in total
                  loans.
 (2)
              Loan
                  fees of $353 and $307 for the three months ending June 30, 2007
                  and 2006,
                  respectively have been included in the interest income computation.
 
 *(dollars
                  in thousands)*
              
              **Average
                  Balance**
                **for
                  the six months ending**
                **June
                  30,**
              
              **Variance**
              
              **Average
                  Yield**
                **for
                  the six months ending**
                **June
                  30,****2007**
              
              **2006**
              
              **dollar**
              
              **percentage**
              
              **2007**
              
              **2006**
              
              **Variance**Interest
                Earning Assets:Time
                  deposits with other banks
              
              $
              318
              
              $
              312
              
              $
              6
              
              
              1.92
              %
              
              3.17
              %
              
              2.59
              %
              
              0.58
              %Investment
                  securities taxable
              
              
              23,924
              
              
              29,250
              
              
              (5,326
              )
              
              -18.21
              %
              
              4.58
              %
              
              4.34
              %
              
              0.24
              %Investment
                  securities non-taxable
              
              
              16,636
              
              
              16,078
              
              
              558
              
              
              3.47
              %
              
              4.30
              %
              
              4.36
              %
              
              -0.06
              %Federal
                  funds sold
              
              
              7,834
              
              
              16,195
              
              
              (8,361
              )
              
              -51.63
              %
              
              4.97
              %
              
              4.77
              %
              
              0.20
              %Loans
                  (1) (2)
              
              
              465,297
              
              
              376,308
              
              
              88,989
              
              
              23.65
              %
              
              8.68
              %
              
              8.31
              %
              
              0.37
              %Total
                  interest earning assets
              
              $
              514,009
              
              $
              438,143
              
              $
              75,866
              
              
              17.32
              %
              
              8.29
              %
              
              7.77
              %
              
              0.52
              %
 
 (1)
              Nonaccrual
                  loans have been included in total loans.
 (2)
              Loan
                  fees of $641 and $657 for the six months ending June 30, 2007 and
                  2006,
                  respectively have been included in the interest income computation.
 
 The
        Company has been able to increase the loan portfolio with continued market
        penetration by a team of seasoned loan officers who are compensated for
        production. Additions to the loan portfolio for the three and six months
        ending
        June 30, 2007 were achieved under the Company’s established Loan Policy.
 
 For
        the
        three and six months ending June 30, 2007 compared to the same period in
        2006,
        the average yield on loans improved by 31 and 37 basis points respectively.
        This
        has been primarily due to the rise in market interest rates from 2006 to
        2007.
        From the end of the first quarter of 2006 to the end of the second quarter
        in
        2007, the Prime rate rose by 50 basis points. See “Item 3. Quantitative and
        Qualitative Disclosure about Market Risk” for further discussion.
 
 The
        taxable investment portfolio gained in average yield due to extension of
        average
        life as the result of rising rates. Balances of taxable investment securities
        decreased due to regular principal reductions on Mortgage Backed Securities
        (MBS).
 
 -
            25
            -
 
 The
        tables below set forth changes for the three and six months ending June 30,
        2007
        compared to the same periods in 2006 for average interest bearing liabilities
        and the respective average rates paid.
 
 *(dollars
                  in thousands)*
              
              **Average
                  Balance**
                **for
                  the three months ending**
                **June
                  30,**
              
              **Variance**
              
              **Average
                  Rate**
                **for
                  the three months ending**
                **June
                  30,****2007**
              
              **2006**
              
              **dollar**
              
              **percentage**
              
              **2007**
              
              **2006**
              
              **Variance**Interest
                Bearing Liabilities:Savings/NOW/money
                  market
              
              $
              181,654
              
              $
              163,633
              
              $
              18,021
              
              
              11.01
              %
              
              2.23
              %
              
              1.47
              %
              
              0.76
              %Time
                  deposits
              
              
              133,377
              
              
              94,605
              
              
              38,772
              
              
              40.98
              %
              
              4.74
              %
              
              4.08
              %
              
              0.66
              %Other
                  borrowings
              
              
              55,607
              
              
              22,652
              
              
              32,955
              
              
              145.48
              %
              
              5.55
              %
              
              5.01
              %
              
              0.54
              %Federal
                  funds purchased
              
              
              1,130
              
              
              257
              
              
              873
              
              
              339.69
              %
              
              5.68
              %
              
              6.24
              %
              
              -0.56
              %Long
                  term debt
              
              
              10,242
              
              
              8,248
              
              
              1,994
              
              
              24.18
              %
              
              7.48
              %
              
              8.90
              %
              
              -1.42
              %Total
                  interest-bearing liabilities
              
              $
              382,010
              
              $
              289,395
              
              $
              92,615
              
              
              32.00
              %
              
              3.74
              %
              
              2.81
              %
              
              0.93
              %
 
 *(dollars
                  in thousands)*
              
              **Average
                  Balance**
                **for
                  the six months ending**
                **June
                  30,**
              
              **Variance**
              
              **Average
                  Rate**
                **for
                  the six months ending**
                **June
                  30,****2007**
              
              **2006**
              
              **dollar**
              
              **percentage**
              
              **2007**
              
              **2006**
              
              **Variance**Interest
                Bearing Liabilities:Savings/NOW/money
                  market
              
              $
              170,263
              
              $
              168,064
              
              $
              2,199
              
              
              1.31
              %
              
              2.05
              %
              
              1.46
              %
              
              0.59
              %Time
                  deposits
              
              
              129,695
              
              
              92,301
              
              
              37,394
              
              
              40.51
              %
              
              4.66
              %
              
              3.92
              %
              
              0.75
              %Other
                  borrowings
              
              
              56,420
              
              
              17,688
              
              
              38,732
              
              
              218.97
              %
              
              5.44
              %
              
              4.82
              %
              
              0.61
              %Federal
                  funds purchased
              
              
              2,123
              
              
              129
              
              
              1,994
              
              
              1545.74
              %
              
              5.70
              %
              
              6.25
              %
              
              -0.55
              %Long
                  term debt
              
              
              13,352
              
              
              8,248
              
              
              5,104
              
              
              61.88
              %
              
              7.91
              %
              
              8.58
              %
              
              -0.67
              %Total
                  interest-bearing liabilities
              
              $
              371,853
              
              $
              286,430
              
              $
              85,423
              
              
              29.82
              %
              
              3.71
              %
              
              2.67
              %
              
              1.04
              %
 
 For
        the
        three and six months ending June 30, 2007 compared to the same period in
        2006,
        the Company’s average yield on average interest bearing liabilities increased by
        93 and 104 basis points respectively.
 
 While
        the
        Company’s balance sheet remains asset sensitive a competitive local market has
        caused deposit costs to outpace loan yields, applying pressure on the net
        interest margin. For the quarter, the net interest margin was 5.56%, down
        slightly form 5.66% for the first quarter and 6.06% for the three months
        ended
        June 30, 2006. The Company’s recent success in deposit gathering has proved to
        be beneficial in helping to reduce higher cost sources of funding, but has
        also
        contributed to the rise in interest expense, which in turn places pressure
        on
        the net interest margin. However, the Company continues to remain committed
        to
        aggressively pursuing core deposits in an effort to provide additional sources
        of inexpensive funding to fuel the continued growth in the loan portfolio.
        Additionally, the re-branding initiative the Company has undertaken has and
        is
        expected to contribute to the acquisition of new low cost deposits.
  -
            26 -
  *Non-Interest
          Income*
 
 The
          tables below set forth changes for the three and six months ending June
          30, 2007
          compared to the same period in 2006 for non-interest income.
 
 **For the three months ended****June
                    30,**
                
                **Variance***(dollars
                    in thousands)*
                
                **2007**
                
                **2006**
                
                **dollar**
                
                **percentage**Service
                    charges on deposit accounts
                
                $
                684
                
                $
                613
                
                $
                71
                
                
                11.6
                %ATM/Debit
                    Card transaction/interchange fees
                
                
                201
                
                
                185
                
                
                16
                
                
                8.6
                %Bancard
                
                
                59
                
                
                29
                
                
                30
                
                
                103.4
                %Mortgage
                    origination fees
                
                
                110
                
                
                157
                
                
                (47
                )
                
                -29.9
                %Earnings
                    on cash surrender value life insurance
                
                
                107
                
                
                92
                
                
                15
                
                
                16.3
                %Other
                
                
                230
                
                
                135
                
                
                95
                
                
                70.4
                %Total
                
                $
                1,391
                
                $
                1,211
                
                $
                180
                
                
                14.9
                %
  **For
                    the six months ended****June
                    30,**
                
                **Variance***(dollars
                    in thousands)*
                
                **2007**
                
                **2006**
                
                **dollar**
                
                **percentage**Service
                    charges on deposit accounts
                
                $
                1,295
                
                $
                1,181
                
                $
                114
                
                
                9.7
                %ATM/Debit
                    Card transaction/interchange fees
                
                
                378
                
                
                359
                
                
                19
                
                
                5.3
                %Bancard
                
                
                117
                
                
                54
                
                
                63
                
                
                116.7
                %Mortgage
                    origination fees
                
                
                259
                
                
                300
                
                
                (41
                )
                
                -13.7
                %Earnings
                    on cash surrender value life insurance
                
                
                213
                
                
                175
                
                
                38
                
                
                21.7
                %Other
                
                
                361
                
                
                360
                
                
                1
                
                
                0.3
                %Total
                
                $
                2,623
                
                $
                2,429
                
                $
                194
                
                
                8.0
                %
  For
          the
          three and six months ending June 30, 2007 as compared to the same period
          in
          2006, non-interest income has risen by approximately $180 thousand and
          $194
          thousand respectively. Service charges on deposit accounts and Bancard
          revenues
          contributed to the majority of the increase in other income for both the
          three
          and six months ended June 30, 2007. These increases are partly attributable
          to
          deposit growth and an increase in the number of customer relationships
          the Bank
          has obtained during 2007.
 
 Mortgage
          origination fees declined in the three and six months ended June 30, 2007,
          when
          compared to the same periods in 2006. The rise in interest rates during
          the
          second quarter of 2007 has made the cost of borrowing less attractive than
          in
          previous quarters and as a result there has been a slowdown in resale
          transactions.
 
 The
          table
          below illustrates the change in the number and total dollar volume of loans
          originated during the three and six months ended June 30, 2007 compared
          to the
          same periods ended in 2006.
 
 **For the three months ended June 30,***(dollars
                    in thousands)*
                
                **2007**
                
                **2006**
                
                **Variance**Dollar
                    volume
                
                $
                14,477
                
                $
                17,023
                
                
                -15.0
                %Number
                    of loans
                
                
                43
                
                
                62
                
                
                -30.6
                %
  **For the six months ended June 30,****2007**
                
                **2006**
                
                **Variance**Dollar
                    volume
                
                $
                29,620
                
                $
                30,731
                
                
                -3.6
                %Number
                    of loans
                
                
                84
                
                
                116
                
                
                -27.6
                %
  -
              27 -
  *Non-Interest
          Expenses*
 
 The
          tables below set forth changes for the three and six months ending June
          30, 2007
          compared to the same period in 2006 for non-interest expense.
  **For the three months ended****June
                    30,**
                
                **Variance***(dollars
                    in thousands)*
                
                **2007**
                
                **2006**
                
                **dollar**
                
                **percentage**Salaries
                    and employee benefits
                
                $
                3,194
                
                $
                2,786
                
                $
                408
                
                
                14.6
                %Occupany
                    and equipment
                
                
                706
                
                
                665
                
                
                41
                
                
                6.2
                %Data
                    processing
                
                
                571
                
                
                534
                
                
                37
                
                
                6.9
                %Advertising
                    and promotional
                
                
                213
                
                
                169
                
                
                44
                
                
                26.0
                %Regulatory
                    fees
                
                
                28
                
                
                28
                
                
                -
                
                
                -Other
                    professional fees and outside services
                
                
                281
                
                
                172
                
                
                109
                
                
                63.4
                %Legal
                    fees and other litigation expense
                
                
                18
                
                
                43
                
                
                (25
                )
                
                -58.1
                %Loan
                    department costs
                
                
                28
                
                
                49
                
                
                (21
                )
                
                -42.9
                %Stationery
                    and supplies
                
                
                78
                
                
                68
                
                
                10
                
                
                14.7
                %Director
                    fees
                
                
                77
                
                
                73
                
                
                4
                
                
                5.5
                %Core
                    deposit intangible amortization
                
                
                88
                
                
                75
                
                
                13
                
                
                17.3
                %Other
                
                
                281
                
                
                386
                
                
                (105
                )
                
                -27.2
                %Total
                
                $
                5,563
                
                $
                5,048
                
                $
                515
                
                
                10.2
                %
  **For the six months ended****June
                    30,**
                
                **Variance***(dollars
                    in thousands)*
                
                **2007**
                
                **2006**
                
                **dollar**
                
                **percentage**Salaries
                    and employee benefits
                
                $
                6,444
                
                $
                5,568
                
                $
                876
                
                
                15.7
                %Occupany
                    and equipment
                
                
                1,421
                
                
                1,268
                
                
                153
                
                
                12.1
                %Data
                    processing
                
                
                1,105
                
                
                1,062
                
                
                43
                
                
                4.0
                %Advertising
                    and promotional
                
                
                427
                
                
                354
                
                
                73
                
                
                20.6
                %Regulatory
                    fees
                
                
                55
                
                
                57
                
                
                (2
                )
                
                -3.5
                %Other
                    professional fees and outside services
                
                
                625
                
                
                408
                
                
                217
                
                
                53.2
                %Legal
                    fees and other litigation expense
                
                
                46
                
                
                60
                
                
                (14
                )
                
                -23.3
                %Loan
                    department costs
                
                
                70
                
                
                82
                
                
                (12
                )
                
                -14.6
                %Stationery
                    and supplies
                
                
                172
                
                
                137
                
                
                35
                
                
                25.5
                %Director
                    fees
                
                
                147
                
                
                148
                
                
                (1
                )
                
                -0.7
                %Core
                    deposit intangible amortization
                
                
                177
                
                
                150
                
                
                27
                
                
                18.0
                %Other
                
                
                567
                
                
                737
                
                
                (170
                )
                
                -23.1
                %Total
                
                $
                11,256
                
                $
                10,031
                
                $
                1,225
                
                
                12.2
                %
 
 Salary
          and Employee Benefits
 
 Salaries
          and employee related expense incurred the greatest dollar increase of any
          non-interest expense category for the three and six months ending June
          30, 2007
          over the same periods ended in 2006. The increase was primarily a result
          of
          increased expenses related to the expansion of our Executive Management
          team
          contributing to higher officer salaries as well as additional staff to
          enhance
          relationship management. The addition of a full service branch within the
          bank’s
          existing footprint in the town of Templeton has resulted in an increase
          in
          salary and employee benefits as well as occupancy expenses.
 
 Other
          Professional Fees and Outside Services
 
 Other
          professional fees and outside service expenses increased for the quarter
          and
          year to date periods ended June 30, 2007 when compared to the same period
          a year
          earlier as a result of increases in a number of sub-categories including
          executive search expenses, consulting fees, audit fees, compliance and
          insurance
          costs. As competition within the primary market area has intensified, the
          Company has found it necessary to use the service of executive search firms
          when
          looking to either replace or add staff. The Company also incurred additional
          expenses within this category related the appraisal of four properties
          that were
          evaluated and later sold in connection with the sale-lease back transaction
          the
          Company disclosed earlier in the quarter.
  -
              28 -
 
 Advertising
          and Promotional
 
 Late
          in
          2006 one of the largest community banks in our market was acquired by a
          major
          multi-national financial services institution. The Company feels that this
          acquisition presents an opportunity for us to acquire new customer
          relationships, as we are now the largest independently owned community
          bank in
          our market. The Company feels the potential to acquire new relationships,
          and in
          turn lower cost core deposits, warrants additional advertising and marketing
          efforts, which have been reflected in this category. During the three and
          six
          months ended June 30, 2007, the Company has begun to see significant rises
          in
          core deposits which can be attributed in part to the additional expenses
          incurred within this category.
 
 Provision
          for Income Taxes
 
 The
          provision for income taxes was 38.3% and 36.1% and 38.1% and 36.7% of net
          pre-tax income for the three and six months ending June 30, 2007 and 2006,
          respectively.
  -
              29 -
  **FINANCIAL
          CONDITION ANALYSIS**
 
 Total
          assets of the Company were $589.9 million at June 30, 2007 compared to
          $541.8
          million at December 31, 2006. This represents an increase of $48.1 million
          or
          approximately 8.9%.
 
 *Loans*
 
 Total
          gross loans as of June 30, 2007, increased by $15.0 million over the year
          ended
          December 31, 2006. The growth in the loan portfolio was primarily attributable
          to a $13.5 million or 15.8% increase in commercial, financial, and agricultural
          loan balances during the first six months of 2007.
 
 The
          table
          below sets forth changes from December 31, 2006 to June 30, 2007 for the
          composition of the loan portfolio :
 
 *(dollars
                    in thousands)*
                
                **June 30,**
                
                **December 31,**
                
                **Variance****2007**
                
                **2006**
                
                **dollar**
                
                **percentage****Loan
                    Classifications:**Commercial,
                    financial, and agricultural
                
                $
                98,440
                
                $
                84,976
                
                $
                13,464
                
                
                15.84
                %Real
                    estate-construction/land
                
                
                100,998
                
                
                105,712
                
                
                (4,714
                )
                
                -4.46
                %Real
                    estate - other
                
                
                245,110
                
                
                237,401
                
                
                7,709
                
                
                3.25
                %Home
                    equity lines of credit
                
                
                9,330
                
                
                10,792
                
                
                (1,462
                )
                
                -13.54
                %Installment
                    loans to individuals
                
                
                5,711
                
                
                5,598
                
                
                113
                
                
                2.01
                %All
                    other loans (including overdrafts)
                
                
                390
                
                
                504
                
                
                (114
                )
                
                -22.64
                %Total
                    loans, gross
                
                
                459,979
                
                
                444,983
                
                
                14,996
                
                
                3.37
                %Less
                    - deferred loan fees, net
                
                
                1,559
                
                
                1,625
                
                
                (66
                )
                
                -4.03
                %Less
                    - reserve for possible loan losses
                
                
                4,520
                
                
                4,081
                
                
                439
                
                
                10.75
                %Total
                    loans, net
                
                $
                453,900
                
                $
                439,277
                
                $
                14,623
                
                
                3.33
                %Loans
                    held for sale
                
                $
                3,329
                
                $
                1,764
                
                $
                1,565
                
                
                88.74
                %
 
 Commercial,
          Financial & Agricultural
 
 The
          increase in commercial, financial and agricultural loans is attributed
          primarily
          to a $2.5 million loan to acquire a chain of hair salons, four loans totaling
          $2.7 million to an oil field maintenance company for equipment, a $1.5
          million
          loan to a winery, a $1.2 million agricultural property loan, $1.2 million
          to an
          accounting firm, $1.1 million to purchase a restaurant and numerous other
          new
          $0.5 to $1.0 million business lines of credit to medical groups, contractors
          and
          others.
 
 Real
          Estate - Construction & Land
 
 The
          decrease in real estate-construction loans can be attributed to construction
          loans moving into longer term mortgages and to payoffs through outside
          sources.
          New loans during the period include: a hotel project for $1.2 million,
          an
          addition to a strip center for $1.5 million, a spec residence for $1.4
          million,
          a warehouse for $1.4 million, commercial/industrial buildings for $4.2
          million,
          a hotel for $1.7 million, a land loan for $1.1 million and numerous other
          smaller projects. Construction loans are typically granted for a one year
          period
          and then, with income properties, are amortized over not more than 30 years
          with
          10 to 15 year maturities.
 
 The
          Bank
          presently has a concentration of loans in construction/land in the amount
          of
          $100.9 million which represents 188% of the Company’s Tier I Capital. Of this,
          47% are owner occupied thus the concentration is 141% net of owner occupied.
          Un-disbursed commitments total $26.6 million which combined with disbursed
          represent 238% of the Bank’s Tier I Capital with 38% owner occupied. At June 30,
          2007 there were 65 construction loans with outstanding balances and remaining
          commitments of approximately $77.8 million and $24.4 million, respectively.
          The
          single largest construction loan has an original commitment amount of
          approximately $12.6 million with a balance of approximately $7.4 million
          at June
          30, 2007. The loan is for an office complex in San Luis Obispo, California.
          At
          June 30, 2007, there were 52 land loans with an aggregate balance of
          approximately $23.2 million. The single largest land loan is for a residential
          tract development with a commitment of $4.8 million and balance of $3.0
          million.
          While these loans may be considered somewhat riskier than certain other
          real
          estate loans, the construction/land loans are spread throughout our market
          area
          and have consistently performed in a satisfactory manner.
  -
              30 -
  Single
          family residence construction loans represent 20.6% of the total construction
          and land loan commitments. Land loans account for 20.6%, multiple family
          income
          properties for 9.8%, owner-occupied commercial properties for 21.3% and
          non-owner-occupied commercial properties for 27.7%. At June 30, 2007, there
          were
          no tract loans within this category.
 
 Real
          Estate - Commercial & Other
 
 The
          increase in commercial real estate loans is attributed to several loans
          in the
          construction/land category moving into amortizing loans and to new commercial
          property loans. However, during the fist six months of 2007, the Bank booked
          new
          loans in this category including an airport fuel/service facility for $4.3
          million, a medical office for $1.3 million, an auto dealership for $1.5
          million,
          a metal fabrication building for $1.0 million and several smaller real
          estate
          loans. Additionally, during the period, numerous loans were also refinanced
          and
          paid off through out of area lenders and mortgage brokers.
 
 Hotel
          loans disbursed are not considered to be a concentration with balances
          of $46.8
          million which represents 95.5% of the Bank’s Tier I Capital. There are several
          hotel construction loans that increase total commitments to $62.1 million
          which
          represents a concentration at 116% of the Bank’s Tier I Capital. At June 30,
          2007, there were 35 motel loans. The single largest loan is a construction
          loan
          for $9.2 million with $8.8 million disbursed, for luxury suite/spa facility
          located in Paso Robles, California. The hotel loans are also made to clients
          throughout our market. These loans have historically paid as agreed.
 
 In
          September 2004, the Bank issued an $11.7 million irrevocable standby letter
          of
          credit to guarantee the payment of taxable variable rate demand bonds.
          The
          primary purpose of the bond issue was to refinance existing debt and provide
          funds for capital improvements and expansion of an assisted living facility
          in
          San Luis Obispo. The project is 100% complete with lease up in process.
          The
          letter of credit will expire in September 2008.
 
 Summary
          of Market Condition
 
 The
          Company’s market area continues to remain attractive with single family
          residence and commercial real estate prices considerably lower than the
          major
          metropolitan areas to the Company’s North and South. However, construction loan
          demand for both single family and commercial real estate moderated during
          the
          first half of 2007, caused primarily by an increase in interest rates,
          construction costs, and a decrease in consumer demand. As a result of slowing
          home sales, some builders have begun to offer buyer incentives, competitive
          mortgage rates, and creative financing options to help spur sales, but
          with
          little success. Although growth in the loan portfolio has moderated during
          the
          first half of 2007, indirectly related to the slowdown in single family
          residential sales, the Company believes the desirability of the area and
          the
          diversity of the portfolio will provide some insulation against a significant
          slowing in growth overall. Additionally, the Company has and will continue
          to
          monitor lending trends in order to take the appropriate steps if necessary
          to
          mitigate any material adverse impact the slowing of the single family
          residential market may have on the loan portfolio overall.
 
 Business
          properties have remained in high demand with relatively low vacancies and
          competitive loan rates. Commercial property values and rental rates increased
          during 2006 and have remained relatively strong in 2007. Lease absorption
          rates
          appear to have slowed during the first half of this year. Investors, many
          seeking exchange properties, continue to pursue properties in our market
          area.
          Capitalization rates have steadily decreased with increased demand.
          Capitalization rate (the rate at which a stream of future cash flows is
          discounted to find their present value) ranges over the last three years
          are:
          6.5% to 7.5% in 2004, 5.5% to 6.5% in 2005, and 5.0% to 6.5% in 2006. Low
          capitalization rate properties typically require larger down payments in
          order
          to satisfy bank debt coverage requirements. The Bank has, thus far, experienced
          continued growth in commercial real estate loans this year. Interest rate
          margins are expected to decrease somewhat due to competitive pressures
          and
          increasing cost of funds.
  -
              31 -
  The
          following charts give a breakdown of types of Construction/Land Loans and
          types
          of Commercial Real Estate loans as of June 30, 2007:
 
 
 
 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
          June
          30, 2007, the Bank had no foreign loans outstanding. The Bank did not have
          any
          concentrations of loans except as disclosed above.
 
 The
          Bank’s management is responsible for monitoring loan performance, which is done
          through various methods, including a review of loan delinquencies and personal
          knowledge of customers. Additionally, the Bank maintains both a “watch” list of
          loans that, for a variety of reasons, management believes requires regular
          review as well as an internal loan classification process. Annually, the
          loan
          portfolio is also reviewed by an experienced, outside loan reviewer not
          affiliated with the Bank. A list of delinquencies, the watch list, loan
          grades
          and the outside loan review are reviewed regularly by the Bank’s Board of
          Directors.
 
 The
          Bank
          has a non-accrual policy that requires a loan greater than 90 days past
          due to
          be placed on non-accrual status unless such loan is well-collateralized
          and in
          the process of collection. When loans are placed on non-accrual status,
          all
          uncollected interest accrued is reversed from earnings. Once on non-accrual
          status, interest on a loan is only recognized on a cash basis. Loans may
          be
          returned to accrual status if management believes that all remaining principal
          and interest is fully collectible and there has been at least six months
          of
          sustained repayment performance since the loan was placed on non-accrual.
          At
          June 30, 2007 non-accrual loans were $555 thousand. Of this balance,
          approximately $277 thousand is secured by a first trust deed and approximately
          $87 thousand is SBA guaranteed.
 
 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.
 
 -
              32 -
  The
          following table provides a summary of non-performing loans and assets as
          of June
          30, 2007 compared to December 31, 2006 as well as key asset quality
          ratios:
 
 **June 30,**
                
                **December 31,***(dollars
                    in thousands)*
                
                **2007**
                
                **2006**Loans
                    delinquent 90 days or more and still accruing
                
                $
                -
                
                $
                -Non-accruing
                    loans
                
                
                555
                
                
                55Total
                    non-performing loans
                
                $
                555
                
                $
                55Foreclosed
                    collateral
                
                
                -
                
                
                -Total
                    non-performing assets
                
                $
                555
                
                $
                55Ratio
                    of allowance for credit losses to total gross loans
                
                
                0.98
                %
                
                0.92
                %Ratio
                    of allowance for credit losses to total non-performing
                    loans
                
                
                814
                %
                
                7420
                %Ratio
                    of non-performing loans to total gross loans
                
                
                0.12
                %
                
                0.01
                %Ratio
                    of non-performing loans to total assets
                
                
                0.09
                %
                
                0.01
                %
  *Total
          Cash and Due from Banks*
 
 Total
          cash and due from banks was $20.9 million and $19.2 million at June 30,
          2007 and
          December 31, 2006, respectively. This line item will vary depending on
          cash
          letters from the previous night and actual cash on hand in the branches.
 
 *Investment
          Securities and Other Earning Assets*
 
 Other
          earning assets are comprised of Federal Home Loan Bank stock, Federal Funds
          sold
          (funds the bank lends on a short-term basis to other banks), investments
          in
          securities and short-term interest bearing deposits at other financial
          institutions. These assets are maintained for liquidity needs of the Bank,
          collateralization of public deposits, and diversification of the earning
          asset
          mix.
 
 The
          table
          below sets forth changes from December 31, 2006 to June 30, 2007 for the
          composition of other earning assets.
 
 **June 30,**
                
                **December 31,**
                
                **Variance***(dollars
                    in thousands)*
                
                **2007**
                
                **2006**
                
                **dollar**
                
                **percentage**Federal
                    Home Loan Bank stock
                
                $
                3,119
                
                $
                2,350
                
                $
                769
                
                
                32.72
                %Available-for-sale
                    securities
                
                
                36,018
                
                
                38,445
                
                
                (2,427
                )
                
                -6.31
                %Federal
                    funds sold
                
                
                43,505
                
                
                3,870
                
                
                39,635
                
                
                1024.16
                %Interest
                    bearing deposits other financial institutions
                
                
                318
                
                
                318
                
                
                -
                
                
                0.00
                %Total
                    other earning assets
                
                $
                82,960
                
                $
                44,983
                
                $
                37,977
                
                
                84.43
                %
 
 Investments
          available-for-sale decreased due to cash flow on Mortgage Backed Securities
          (MBS) and Collateralized Mortgage Obligations (CMO).
 
 Federal
          funds sold increased $39.6 million when compared to December 31, 2006.
          The
          amount of Fed funds sold can vary widely on a daily basis depending on
          the cash
          position of the bank which is affected by numerous variables such as cash
          letters, incoming and outgoing wire activity, and loan funding
          needs.
 
 The
          Company manages its securities portfolio to provide a source of both liquidity
          and earnings. The Bank has an asset/liability committee that develops current
          investment policies based upon its operating needs and market circumstance.
          The
          Bank’s investment policy is formally reviewed and approved annually by the board
          of directors. The asset/liability committee of the Bank
          is
          responsible for reporting and monitoring compliance with the investment
          policy.
          Reports are provided to the Bank’s boards of directors on a regular basis.
  -
              33 -
  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. At December 31, 2006, net unrealized gains in the portfolio were
          $133
          thousand or $80 thousand, net of tax compared to a net unrealized loss
          of $278
          thousand or $167 thousand, net of tax at June 30, 2007. This change in
          market
          value was driven in part by a year to date increase in interest rates,
          with the
          10-year treasury yield increasing by approximately 32bp during the first
          half of
          2007. The portfolio decreased in size mainly due to principle reductions
          on MBS
          and CMOs of approximately $2,057 thousand during the first six months of
          2007.
 
 At
          June
          30, 2007, available-for-sale securities in the portfolio included obligations
          of
          state and political subdivisions, obligations of U.S. government agencies
          and
          corporations and mortgage backed securities issued by various agencies.
 
 All
          fixed
          and adjustable rate mortgage pools contain a certain amount of risk related
          to
          the uncertainty of prepayments of the underlying mortgages. Interest rate
          changes have a direct impact upon prepayment rates. The Bank uses computer
          simulation models to test the average life, duration, market volatility
          and
          yield volatility of adjustable rate mortgage pools under various interest
          rate
          assumptions to monitor volatility. Stress tests are performed quarterly.
 
 *Deposits
          and Borrowed Funds*
 
 The
          table
          below sets forth changes from December 31, 2006 to June 30, 2007 for the
          composition of deposit categories.
 
 **% of Total***(dollars
                    in thousands)*
                
                **June
                    30,**
                
                **December 31,**
                
                **Variance**
                
                **Deposits****2007**
                
                **2006**
                
                **dollar**
                
                **percentage**
                
                **6/30/07**Deposits:Non-interest
                    bearing demand
                
                $
                153,485
                
                $
                153,005
                
                $
                480
                
                
                0.31
                %
                
                31.4
                %Interest
                    bearing demand
                
                
                57,288
                
                
                45,164
                
                
                12,124
                
                
                26.84
                %
                
                11.7
                %Savings
                
                
                23,240
                
                
                23,406
                
                
                (166
                )
                
                -0.71
                %
                
                4.8
                %Money
                    market
                
                
                113,192
                
                
                77,540
                
                
                35,652
                
                
                45.98
                %
                
                23.1
                %Time
                    deposits of $100K or more
                
                
                44,141
                
                
                30,630
                
                
                13,511
                
                
                44.11
                %
                
                9.0
                %Time
                    deposits under $100K
                
                
                97,761
                
                
                90,776
                
                
                6,985
                
                
                7.69
                %
                
                20.0
                %Total
                    deposits
                
                $
                489,107
                
                $
                420,521
                
                $
                68,586
                
                
                16.31
                %
                
                100
                %
  Acquisition
          of core deposits has become the single biggest challenge facing the Company.
          Still, the Company has been able to increase deposits due to a well planned
          marketing strategy and incentive based compensation that has been in place
          for
          several years. Like all good strategies, this one is fluid and is subject
          to the
          changing dynamics within the Company’s balance sheet and staffing along with
          changes in its primary market area. A shift to higher balances in time
          deposits
          is the result of fierce competition for deposits driving up short term
          CD rates,
          which has resulted from increased demand in funding for loans. Additionally,
          the
          rise in money market balances is in part the result of current promotions
          designed to attract additional core deposits. This promotion has proved
          to be
          successful thus far, as the Company has been able to increase money market
          balances by approximately $36 million during the six months ended June
          30,
          2007.
 
 At
          June
          30, 2007, non-interest bearing demand deposits provide 31.4% of total deposits
          compared to 36.4% at December 31, 2006. At June 30, 2007 and December 31,
          2006,
          the Bank had three deposit relationships that it considers to be volatile.
          These
          deposits are held by three customers of the Bank that engage in mortgage
          related
          activities. As a percentage of total deposits, these accounts represented
          8.4%
          or $41.3 million at June 30, 2007 compared to 10.5% or $44.1 million at
          December
          31, 2006. These volatile account relationships are included in the volatile
          liability dependency report that the Bank produces on a monthly basis.
          Typically, a material increase in balances held by these three customers
          is
          reflected in Federal Funds Sold and is recognized by Management to potentially
          be short term in nature. Therefore, any material increase in these balances
          is
          not considered to be a funding source for any form of long-term investment.
          Management and the Board of Directors of the Bank are keenly aware that
          as the
          mortgage market conditions change, these relationships will be impacted.
 
 Core
          deposits (time deposits less than $100 thousand, demand, and savings) gathered
          in the local communities served by the Company continue to be the primary
          source
          of funds for loans and investments. Core deposits of $445.0 million represented
          91.0% of total deposits at June 30, 2007. This represents an increase of
          approximately $55.1 million or 14.1% over core deposit
          balances of $389.9 million reported at December 31, 2006. The Company has
          the
          ability to purchase funds through deposit brokers, but has no immediate
          plans to
          do so.
  -
              34 -
  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
          June 30, 2007, the Company had a zero balance outstanding on this note.
          The
          Company pledged 646,598 shares (51%) of the Bank’s stock as collateral for the
          loan. The note is revolving in nature for the first two years. The terms
          of the
          note call for quarterly interest only payments for the first two years
          with
          subsequent principal and interest payments for eight years on a fully amortized
          basis. At June 30, 2007, the interest rate on the note was 8.25% and is
          variable
          and moves with prime. Under the terms of the agreement, the Company will
          not
          incur any additional debt over $2 million exclusive of inter-company debt
          and
          existing debt without the prior written consent of PCBB. In addition, the
          Bank
          must be “well” capitalized on an on-going basis as defined by bank regulators.
 
 The
          Bank
          has established borrowing lines with the Federal Home Loan Bank (FHLB).
          At June
          30, 2007, the Bank had borrowings with the FHLB of $30.0 million collateralized
          by loans. The weighted average interest rate associated with these borrowings
          as
          of June 30, 2007 was 5.38%.
 
 The
          table
          below sets forth the various advances the Bank has obtained from the FHLB
          as of
          June 30, 2007:
 
 *(dollars
                    in thousands)*
  **Amount**
                
                **Interest**
                
                **Maturity****Borrowed**
                
                **Rate**
                
                **Variable/Fixed**
                
                **Date**$
                10,000
                
                
                5.39
                %
                Variable
                
                9/28/0710,000
                
                
                5.37
                %
                Variable
                
                11/26/0710,000
                
                
                5.37
                %
                Variable
                
                12/12/07$
                30,000
                
                
                5.38
                %
 
 During
          the second quarter of 2007, the Bank paid down $20 million in FHLB advances.
          Strength in lower cost core deposit balances during the quarter has allowed
          the
          Bank to rely less on these higher cost sources of funding.
  Upon
          maturity of the various advances shown in the table above, Management will
          assess balance sheet needs and determine how much if any and at what term
          it
          will borrow from the FHLB.
 
 On
          September 17, 2004, the Bank issued a Letter of Credit in the amount of
          approximately $11.7 million to a customer in regard to a senior care facility.
          The Letter of Credit was issued pursuant to a Letter of Credit Reimbursement
          Agreement between the Bank and the FHLB. It is collateralized by a blanket
          lien
          with the FHLB that includes all qualifying loans on the Bank’s balance sheet.
 
 At
          June
          30, 2007, the Bank has a remaining borrowing capacity with existing collateral
          of approximately $83.3 million and $5.5 million secured by loans and securities,
          respectively.
 
 The
          Bank
          utilizes securities sold under repurchase agreements as a source of funds.
          The
          Bank had $1.4 million in securities sold under repurchase agreements at
          June 30,
          2007 and December 31, 2006.
  *Capital*
 
 The
          Company's total stockholders’ equity was $52.5 million at June 30, 2007 compared
          to $49.5 million at December 31, 2006. The increase in capital was due
          to net
          income of $3.3 million, stock options exercised in the amount of $825 thousand,
          the capital impact of year-to-date share-based compensation expense of
          $184
          thousand, $1,024 thousand paid year-to-date in quarterly cash dividends,
          and a
          decrease in accumulated other comprehensive income of $247 thousand.
 
 Dividends
 
 On
          July
          18, 2007, the Board of Directors declared a quarterly cash dividend of
          $0.08 per
          share to be paid on August 17, 2007 to shareholders of record on August
          3, 2007.
 
 On
          April
          20, 2007, the Board of Directors declared a quarterly cash dividend of
          $0.08 per
          share to be paid on May 18, 2007 to shareholders of record on May 4, 2007.
  -
              35 -
  On
          January 19, 2007, the Board of Directors declared a quarterly cash dividend
          of
          $0.08 per share to be paid on February 16, 2007 to shareholders of record
          on
          February 2, 2007.
 
 On
          October 20, 2006, the Board of Directors declared a quarterly cash dividend
          of
          $0.08 per share to be paid on November 17, 2006 to shareholders of record
          on
          November 3, 2006
 
 On
          July
          21, 2006, the Board of Directors declared a quarterly cash dividend of
          $0.08 per
          share to be paid on August 25, 2006 to shareholders of record on August
          11,
          2006.
 
 On
          April
          21, 2006 the Company declared a $0.25 per share special cash dividend to
          be paid
          on May 19, 2006 to shareholders of record on May 8, 2006. The special dividend
          was declared in lieu of recent annual stock dividends the Company has declared.
 
 Stock
          Repurchases
 
 On
          July
          21, 2006, the Board of Directors adopted a resolution authorizing the repurchase
          of up to 40,000 shares of the Company’s common stock. Purchases are to be made,
          as conditions warrant, from time to time in the open market or through
          privately
          negotiated transactions. The duration of the program is one year and the
          timing
          of purchases will depend on market conditions.
 
 On
          October 20, 2006, the Board of Directors adopted a resolution to increase
          the
          number of shares available for repurchase to 100,000 for the repurchase
          plan
          that was adopted in July 2006.
 
 On
          July
          18, 2007, the Board of Directors authorized a one year extension of the
          stock
          repurchase program that was adopted in July 2006. Under the one year extension
          the Company may repurchase up to 100,000 shares of its common stock, of
          which
          40,000 shares have already been repurchased under the current plan.
 
 Trust
          Preferred Securities
 
 On
          April
          10, 2002, the Company issued $8,248,000 of Floating Rate Junior Subordinated
          Deferrable Interest Debentures (the “debt securities”) to Heritage Oaks Capital
          Trust I, a statutory trust created under the laws of the State of Delaware.
          These debt securities are subordinated to effectively all borrowings of
          the
          Company and are due and payable on April 22, 2032. Interest is payable
          semi-annually on these debt securities at 6-Month LIBOR plus 3.7%. The
          debt
          securities can be called at any time commencing on April 22, 2007, at par.
          The
          debt securities can also be redeemed at par if certain events occur that
          impact
          the tax treatment, regulatory treatment or the capital treatment of the
          issuance. The Company also purchased a 3% minority interest totaling $248
          thousand in Heritage Oaks Capital Trust I. The balance of the equity of
          Heritage
          Oaks Capital Trust I is comprised of mandatory redeemable preferred securities
          and is included in other assets. The Company used the proceeds from the
          sale of
          the securities for general corporate purposes, including the repayment
          of
          outstanding indebtedness of $1.9 million on April 11, 2002 and capital
          contributions to the Bank for future growth.
 
 On
          April
          23, 2007 the Company redeemed all of the Floating Rate Junior Subordinated
          Debt
          Securities it held associated with Heritage Oaks Capital Trust I, a wholly-owned
          subsidiary of Heritage Oaks Bancorp. The redemption price was 100% of the
          principal amount redeemed plus accrued and unpaid interest as of the Redemption
          Date. The Company paid $379,011 for the standard interest payment due April
          22,
          2007, plus a payment of $8,248,000 for the principal amount to be redeemed
          on
          that date. These amounts were funded from the Company’s general corporate
          reserves. As a result of the redemption of the securities associated with
          Heritage Oaks Capital Trust I, the Trust was dissolved on June 1,
          2007.
 
 On
          October 27, 2006, the Company issued $8,248,000 of Floating Rate Junior
          Subordinated Deferrable Interest Debentures (the “debt securities”) to Heritage
          Oaks Capital Trust II, a statutory trust created under the laws of the
          State of
          Delaware. These debt securities are subordinated to effectively all borrowings
          of the Company and are due and payable on October 27, 2036. Interest is
          payable
          quarterly on these debt securities at 3-Month LIBOR plus 1.71% for an effective
          rate of 7.07% as of June 30, 2007. The debt securities can be called at
          any time
          commencing on October 27, 2011, at par. The debt securities can also be
          redeemed
          at par if certain events occur that impact the tax treatment or the capital
          treatment of the issuance. The Company also purchased a 3% minority interest
          totaling $248,000 in Heritage Oaks Capital Trust II. The balance of the
          equity
          of Heritage Oaks Capital Trust II is comprised of mandatory redeemable
          preferred
          securities and is included in other assets.
 
 The
          Company intends to use the proceeds of the sale of the Trust Preferred
          Securities issued to Heritage Oaks Capital Trust II for general corporate
          purposes which may include investment in the Bank, acquisitions, investments,
          payment of dividends and repurchases of our outstanding common stock.
  -
              36 -
  Under
          FASB Interpretation (FIN) No. 46, “Consolidation of Variable Interest Entities,
          an interpretation of ARB No. 51,” the Company is not allowed to consolidate
          Heritage Oaks Capital Trust I and II into the Company’s financial statements.
          Prior to the issuance of FIN No. 46, Bank holding companies typically
          consolidated these entities. On February 28, 2005, the Federal Reserve
          Board
          issued a new rule which provides that, notwithstanding the deconsolidation
          of
          such trusts, junior subordinated debentures, such as those issued by the
          Company, may continue to constitute up to 25% of a bank holding company's
          Tier 1
          capital, subject to certain new limitations which will not become effective
          until March 31, 2009 and which, in any event, are not expected to affect
          the
          treatment of the Company's Junior Subordinated Debentures as Tier 1 capital
          for
          regulatory purposes. As of June 30, 2007, the Company has included $8.0
          million
          of net junior subordinated debt associated with Heritage Oaks Capital Trust
          II
          in its Tier I Capital for regulatory capital purposes.”
 
 If
          the
          Company elects to defer interest payments pursuant to terms of the agreement,
          then the Company may not (i) declare or pay any dividends or distributions
          on,
          or redeem, purchase, acquire or make a liquidation payment with respect
          to any
          of the Company’s capital stock, or (ii) make any payment of principal of or
          premium, if any, or interest on or repay, repurchase or redeem any debt
          securities of the Company that rank pari passu with or junior in interest
          to the
          Debt Securities, other than, among other items, a dividend in the form
          of stock,
          warrants, options or other rights in the same stock as that on which the
          dividend is being paid or ranks pari passu with or junior to such stock.
          The
          prohibition on payment of dividends and payments on pari passu or junior
          debt
          also applies in the case of an event of default under the
          agreements.
 
 At
          June
          30, 2007, the Company had sufficient cash to service the existing $8.2
          million
          in junior subordinated debenture interest payments for approximately two
          years
          without dividends from subsidiaries. The Bank’s capacity to provide cash to the
          Company, while remaining “well-capitalized”, was $7.1 million at June 30,
          2007.
 
 The
          Company is currently obtaining term bids to issue additional trust preferred
          securities in the amount of $8 million prior to the close of the pending
          acquisition of Business First National Bank. The acquisition is anticipated
          to
          close in the fourth quarter of 2007.
 
 Regulatory
          Capital Requirements
 
 Capital
          ratios for commercial banks in the United States are generally calculated
          using
          three different formulas. These calculations are referred to as the “Leverage
          Ratio” and two “risk-based” calculations known as: “Tier One Risk Based Capital
          Ratio” and the “Total Risk Based Capital Ratio.” These standards were developed
          through joint efforts of banking authorities from 12 different countries
          around
          the world. The standards essentially take into account that different types
          of
          assets have different levels of risk associated with them. Furthermore,
          they
          take into account the off-balance sheet exposures of banks when assessing
          capital adequacy.
 
 The
          Leverage Ratio calculation simply divides common stockholders’ equity (reduced
          by any goodwill a bank may have) by the total assets. In the Tier One Risk
          Based
          Capital Ratio, the numerator is the same as the leverage ratio, but the
          denominator is the total “risk-weighted assets”. Risk weighted assets are
          determined by segregating all the assets and off balance sheet exposures
          into
          different risk categories and weighting them by a percentage ranging from
          0%
          (lowest risk) to 100% (highest risk). The Total Risk Based Capital Ratio
          again
          uses “risk-weighted assets” in the denominator, but expands the numerator to
          include other capital items besides equity such as a limited amount of
          the loan
          loss reserve, long-term capital debt, preferred stock and other instruments.
 
 Summarized
          below are the Company’s and the Bank’s capital ratios at June 30, 2007.
 
 **Regulatory Standard****Adequately**
                
                **Well**
                
                **Heritage Oaks**
                
                **Heritage Oaks****Capitalized**
                
                **Capitalized**
                
                **Bancorp**
                
                **Bank**Leverage
                    Ratio
                
                
                4.00
                %
                
                5.00
                %
                
                9.58
                %
                
                9.43
                %Tier
                    I Risk Based Captial Ratio
                
                
                4.00
                %
                
                6.00
                %
                
                10.64
                %
                
                10.48
                %Total
                    Risk Based Captial Ratio
                
                
                8.00
                %
                
                10.00
                %
                
                11.55
                %
                
                11.39
                %
  -
              37 -
  *Liquidity*
 
 The
          objective of liquidity management is to ensure the continuous availability
          of
          funds to meet the demands of depositors, investors and borrowers. Asset
          liquidity is primarily derived from loan payments and the maturity of other
          earning assets. Liquidity from liabilities is obtained primarily from the
          receipt of new deposits. The Bank’s Asset Liability Committee (ALCO) is
          responsible for managing the on and off-balance sheet commitments to meet
          the
          needs of customers while achieving the Bank’s financial objectives. ALCO meets
          regularly to assess the projected funding requirements by reviewing historical
          funding patterns, current and forecasted economic conditions and individual
          customer funding needs. Deposits generated from Bank customers serve as
          the
          primary source of liquidity. The Bank has credit arrangements with correspondent
          banks that serve as a secondary liquidity source in the amount of $13.5
          million.
          As of June 30, 2007, the Bank had no borrowings against credit arrangements
          with
          these correspondent banks. The Bank is also member of the FHLB and has
          a
          collateralized borrowing capacity remaining of approximately $88.8 million.
 
 The
          Bank
          manages liquidity by maintaining a majority of the investment portfolio
          in
          federal funds sold and other liquid investments. At June 30, 2007, the
          ratio of
          liquid assets not pledged for collateral and other purposes to deposits
          and
          other liabilities was 16.66% compared to 9.31% at December 31, 2006. The
          ratio
          of net loans to deposits was 92.8% at June 30, 2007 compared to 104.5%
          at
          December 31, 2006. The ratio of net loans to available funding sources,
          which
          takes into account all funding sources including those other than deposits
          such
          as FHLB lines, was 73.75% at June 30, 2007 compared to 82.93% at December
          31,
          2006.
  *Inflation*
 
 The
          assets and liabilities of a financial institution are primarily monetary
          in
          nature. As such they represent obligations to pay or receive fixed and
          determinable amounts of money that are not affected by future changes in
          prices.
          Generally, the impact of inflation on a financial institution is reflected
          by
          fluctuations in interest rates, the ability of customers to repay debt
          and
          upward pressure on operating expenses. The effect of inflation over the
          past two
          years has been significant to the Company’s financial position and results of
          operations in regard to fluctuation in interest rates. The increase in
          interest
          rates has created a narrowing of the net interest margin and the Company
          continues to experience contraction. There has been a great deal of news
          in the
          national media related to the rising rate environment leading to the inability
          of some borrowers in the single family residential sub-prime and alt- a
          markets
          to repay their debt. However, the Company’s primary focus is commercial lending
          and the strong underwriting requirements of the Company has continued to
          lend
          itself to outstanding asset quality as evidenced by a 0.12% non-performing
          loan
          to total net loan ratio as of June 30, 2007.
  *Off-Balance
          Sheet Arrangements*
 
 Off-balance
          sheet arrangements are any contractual arrangement to which an unconsolidated
          entity is a party, under which the Company has: (1) any obligation under
          a
          guarantee contract; (2) a retained or contingent interest in assets transferred
          to an unconsolidated entity or similar arrangement that serves as credit,
          liquidity or market risk support to that entity for such assets; (3) any
          obligation under certain derivative instruments; or (4) any obligation
          under a
          material variable interest held by the Company in an unconsolidated entity
          that
          provides financing, liquidity, market risk or credit risk support to the
          Company, or engages in leasing, hedging or research and development services
          with the Company.
 
 In
          the
          ordinary course of business, the Company has entered into off-balance sheet
          financial instruments consisting of commitments to extend credit, commercial
          letter of credit, and standby letter of credit. Such financial instruments
          are
          recorded in the financial statement when they are funded or related fees
          are
          incurred or received. For a fuller discussion of these financial instruments,
          refer to Note 10 of the Company’s consolidated financial statements contained in
          Item 8 of Part II of the Company’s December 31, 2006 10-K.
 
 In
          the
          ordinary course of business, the Bank is a party to various operating leases.
          For a fuller discussion of these financial instruments, refer to Note 5
          of the
          Company’s consolidated financial statements contained in Item 8 of Part II of
          the Company’s December 31, 2006 10-K.
 
 In
          connection with the $8.2 million in debt securities discussed in “ *Capital* ,”
the
          Company issued the full and unconditional payment guarantee of certain
          accrued
          distributions.
  -
              38 -
  **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 $8.2 million in
          subordinated debentures issued by the Company’s subsidiary grantor trusts. As a
          result, all significant interest rate risk procedures are performed at
          the
          banking subsidiary level. The subsidiary bank’s real estate loan portfolio,
          concentrated primarily within Northern Santa Barbara County and San Luis
          Obispo
          County, California, are subject to risks associated with the local
          economy.
  The
          fundamental objective of the Company’s management of its assets and liabilities
          is to maximize the Company’s economic value while maintaining adequate liquidity
          and an exposure to interest rate risk deemed by Management to be acceptable.
          Management believes an acceptable degree of exposure to interest rate risk
          results from the management of assets and liabilities through maturities,
          pricing and mix to attempt to neutralize the potential impact of changes
          in
          market interest rates. The Company’s profitability is dependent to a large
          extent upon its net interest income, which is the difference between its
          interest income on interest-earning assets, such as loans and investments,
          and
          its interest expense on interest-bearing liabilities, such as deposits
          and
          borrowings. The Company is subject to interest rate risk to the degree
          that its
          interest-earning assets re-price differently than its interest-bearing
          liabilities. The Company manages its mix of assets and liabilities with
          the
          goals of limiting its exposure to interest rate risk, ensuring adequate
          liquidity, and coordinating its sources and uses of funds.
  The
          Company seeks to control interest rate risk exposure in a manner that will
          allow
          for adequate levels of earnings and capital over a range of possible interest
          rate environments. The Company has adopted formal policies and practices
          to
          monitor and manage interest rate risk exposure.  Management believes
          historically it has effectively managed the effect of changes in interest
          rates
          on its operating results.  Management believes that it can continue to
          manage the short-term effect of interest rate changes under various interest
          rate scenarios.
  Management
          employs the use of an Asset and Liability Management software that is used
          to
          measure the Bank’s exposure to future changes in interest rates. This model
          measures the expected cash flows and re-pricing of each financial
          asset/liability separately in measuring the Bank’s interest sensitivity. Based
          on the results of this model, management believes the Bank’s balance
          sheet is “asset sensitive”. This means the Company expects (all other
          things being equal) to expand its net interest income if rates rise and
          expects
          it conversely to contract if rates fall.  The level of potential or
          expected contraction indicated by the tables below is considered acceptable
          by
          management and is compliant with the Bank’s ALCO policies.  Management will
          continue to perform this analysis each quarter to further validate the
          expected
          results against actual data.
  The
          hypothetical impacts of sudden interest rate movements applied to the Company’s
          asset and liability balances are modeled monthly. The results of this movement
          indicate how much of the Company’s net interest income is “at risk” from various
          rate changes over a one year horizon. This exercise is valuable in identifying
          risk exposures. Management believes the results for the Company’s June 30, 2007
          balances indicate that the net interest income at risk over a one year
          time
          horizon for a 1% and 2% rate increase and decrease is acceptable at this
          time.
 
 The
          results in the table below indicate the change in net interest income the
          Company would expect to see as of June 30, 2007, if interest rates were
          to
          change in the amounts set forth:
 
 **Shock
                    Rate Scenarios***(dollars
                    in thousands)*
                
                **-200bp**
                
                **-100bp**
                
                **Base**
                
                **+100bp**
                
                **+200bp**Net
                    interest income (NII)
                
                $
                25,244
                
                $
                26,755
                
                $
                28,421
                
                $
                30,117
                
                $
                31,819$
                    Change from base
                
                $
                (3,177
                )
                $
                (1,665
                )
                $
                -
                
                $
                1,696
                
                $
                3,398%
                    Change from base
                
                
                -11.18
                %
                
                -5.86
                %
                
                0.00
                %
                
                5.97
                %
                
                11.96
                %
  -
              39 -
  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.
 
 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 at
          June 30,
          2007.
 
 *(dollars
                    in thousands)***Total
                    Gross Loans**
                
                **Percent of****Rate
                    Type**
                
                **Balance**
                
                **Total**Variable
                    - daily
                
                $
                188,635
                
                
                41
                %Variable
                    other than daily
                
                
                202,473
                
                
                44
                %Fixed
                    rate
                
                
                68,871
                
                
                15
                %Total
                    gross loans
                
                $
                459,979
                
                
                100
                %
 
 
 The
          table
          above identifies approximately 41.0% of the loan portfolio that will re-price
          immediately in a changing rate environment. At June 30, 2007, approximately
          85.0% of the Bank’s loan portfolio is variable.
 
 *(dollars
                    in thousands)***Total
                    Gross Loans**
                
                **Percent of****Re-Pricing**
                
                **Balance**
                
                **Total**<
                    1 Year
                
                $
                265,587
                
                
                58
                %1-3
                    Years
                
                
                119,543
                
                
                26
                %3-5
                    Years
                
                
                50,439
                
                
                11
                %>
                    5 Years
                
                
                24,410
                
                
                5
                %Total
                    gross loans
                
                $
                459,979
                
                
                100
                %
  The
          table
          above indicates that as of June 30, 2007, approximately 58.0% of the Bank’s loan
          portfolio will re-price within one year and approximately 84.0% of the
          Bank’s
          loan portfolio will re-price within three years.
  **Item
          4.**  **Controls
          and Procedures**
 
 *Evaluation
          of Disclosure Controls and Procedures*
 
 As
          of the
          end of the period covered by this report, the Company carried out an evaluation,
          under the supervision and with the participation of its management, including
          the Company’s Chief Executive Officer and Chief Financial Officer, of the
          effectiveness of the design and operation of the Company’s disclosure controls
          and procedures pursuant to Exchange Act Rules 13a-15 and 15d-15. Based
          upon that
          evaluation, the Chief Executive Officer and Chief Financial Officer concluded
          that the Company’s disclosure controls and procedures are effective to provide
          reasonable assurances that information required to be disclosed in the
          reports
          the Company files or submits under the Securities Exchange Act of 1934
          is
          recorded, processed, summarized and reported within the time periods specified
          in the SEC’s rules and forms.
 
 There
          was
          no change in the Company’s internal controls over financial reporting during the
          quarter ended June 30, 2007 that has materially affected, or is reasonably
          likely to materially affect, the Company’s internal controls over financial
          reporting.
 
 In
          designing and evaluating disclosure controls and procedures, the Company’s
          management recognized that any controls and procedures, no matter how well
          designed and operated, can provide only reasonable, not absolute, assurances
          of
          achieving the desired control objectives and management necessarily was
          required
          to apply its judgment in evaluating the cost-benefit relationship of possible
          controls and procedures.
 
 -
              40 -
  **PART
          2. OTHER INFORMATION**
 
 **Item
          1.**  **Legal
          Proceedings**
 
 The
          Company is not a party to any material legal proceeding.
  **Item
          1A.Risk Factors**
 
 During
          the period covered by this report there were no material changes from risk
          factors as previously disclosed in the Company’s December 31, 2006 10k in
          response to Item A to Part I of Form 10k.
  **Item
          2.**  **Changes
          in Securities, Use of Proceeds and Issuer Purchases of Equity
          Securities**
 
 *Unregistered
          Sale of Equity Securities*
 
 None.
 
 *Purchases
          of Equity Securities*
 
 On
          July
          21, 2006, the Board of Directors adopted a one year stock repurchase plan
          in the
          initial amount of 40,000 shares. In October 2006, the Board of Directors
          adopted
          a resolution to increase the total number of shares available for repurchase
          under the plan to 100,000.
 
 As
          of
          December 31, 2006, the Company had repurchased 40,000 shares of its common
          stock
          under the repurchase plan at an average market price of $17.95 per share.
          As of
          June 30, 2007, there were 60,000 shares of common stock available for purchase
          under the repurchase plan. During the three months ending June 30, 2007,
          the
          company made no additional purchases of its common stock under the repurchase
          plan.
 
 On
          July
          18, 2007, the Board of Directors authorized a one year extension of the
          stock
          repurchase program that was adopted in July 2006. Under the one year extension
          the Company may repurchase up to 100,000 shares of its common stock, of
          which
          40,000 shares have already been repurchased under the current plan.
  -
              41 -
  **Item
          3.**  **Defaults
          Upon Senior Securities**
 
 N/A
  **Item
          4.**  **Submission
          of Matters to a Vote of Security Holders**
 
 The
          information required by this item is hereby incorporated by reference from
          the
          Registrant’s 8-K filed with the Commission on May 30, 2007.
  **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
  -
              42 -
  **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:
          July 27, 2007
   /s/
                    Lawrence P. Ward
                  
                  Lawrence
                    P. WardPresidentChief
                    Executive Officer/s/
                    Margaret A. Torres
                  
                  Margaret
                    A. TorresExecutive
                  Vice PresidentChief
                    Financial Officer(Principal
                    Financial and Accounting Officer)
 
 -
            43
            -