Unassociated Document

The requirement to obtain consent from the U.S. Treasury for any proposed increases in common stock dividends prior to the third anniversary date of the preferred equity issuance.

The Series A Senior Preferred Stock cannot be redeemed for three years unless the Company obtains proceeds to replace the Series A Senior Preferred Stock through a qualified equity offering.

The U.S. Treasury must consent to any buy back of our common stock.

The Company must adhere to restrictions placed on the amount of and type of compensation paid to its executives while participating in the CPP, pursuant to section 111 of the Emergency Economic Stabilization Act of 2008, as amended (“EESA”).

In the second quarter of 2010 the Company was required to defer dividend payments on its Series A Senior Preferred Stock to comply with the terms of the Written Agreement entered into between the Company and the Federal Reserve Company of San Francisco. As a result, as of September 30, 2010, the Company has accrued for but has not paid approximately $0.5 million in dividends on its Series A Senior Preferred Stock. If the Company fails to pay dividends on Series A Senior Preferred Stock for a total of six quarters, whether or not consecutive, the U.S. Treasury will have the right to elect two members of the Company’s Board of Directors, voting together with any other holders of preferred shares ranking pari passu with the Series A Senior Preferred Stock. These directors would serve on the Company’s Board of Directors until such time as the Company has paid in full all dividends not previously paid, at which time these directors’ terms of office would immediately terminate. As of September 30, 2010, the Company has not paid dividends on Series A Preferred Stock for two consecutive quarters.

For more information concerning the Written Agreement, please refer to Note 12. Regulatory Order and Written Agreement of these consolidated financial statements.

Private Placement and Preferred Stock Conversion

On March 12, 2010 the Company announced that it completed a private placement of 52,088 shares of its Series B Mandatorily Convertible Adjustable Cumulative Perpetual Preferred Stock ("Series B Preferred Stock") and 1,189,538 shares of its Series C Convertible Perpetual Preferred Stock (“Series C Preferred Stock”), raising gross proceeds of approximately $56.0 million. In addition, approximately $4.0 million was placed in escrow for a second closing of 4,072 shares of Series B Preferred Stock, which then closed during the second quarter of 2010. Total gross proceeds raised in the private placement were approximately $60.0 million and total costs associated with the capital raising efforts were approximately $4.0 million, which represent a reduction of the addition to equity from the private placement.

In June 2010, the Company received shareholder approval to convert all outstanding shares of Series B Preferred Stock to common stock and as a result the Company issued 17,279,995 shares of common stock in June 2010.

The Series B Preferred Stock was mandatorily convertible into common stock, upon the approval by shareholders of the Company’s common stock at a conversion price of $3.25 per common share. As indicated above, shareholder approval occurred during the second quarter of 2010. The conversion price of $3.25 per common share was less than the fair market value of the Company’s common stock on March 10, 2010, (the “commitment date”) the date the Company made a firm commitment to issue the Series B Preferred Stock. The fair market value of the Company’s common stock on the commitment date was $3.45 per share. Therefore, the Series B Preferred Stock was issued with a contingent beneficial conversion feature that had an intrinsic value equal to the $0.20 per share difference between the share price on the commitment date and the conversion price of the Series B Preferred Stock. The intrinsic value of the beneficial conversion feature related to the entire Series B Preferred Stock issuance was $3.5 million. The recognition of the beneficial conversion feature was contingent upon the approval of the Company’s shareholders of the conversion of the Series B Preferred Stock to common stock and thus was recognized in June 2010 when such approval was received at the Company’s annual meeting of shareholders.

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Notes to Consolidated Financial Statements

Upon conversion of the Series B Preferred Stock the related beneficial conversion feature was recorded in conjunction with the establishment of a discount on the Series B Preferred Stock and a corresponding increase in additional paid in capital. The immediate accretion of the entire Series B Preferred Stock discount occurred through a charge to retained earnings on June 11, 2010, the date the Company converted the outstanding Series B Preferred Stock to common stock.

Series C Preferred Stock is a non-voting class of stock substantially similar in priority to the common stock of the Company, except for a liquidation preference over the Company’s common stock. The Series C Preferred Stock will convert to shares of common stock on a one share for one share basis if the original holder of such shares transfers them to an unaffiliated third party. The Series C Preferred Stock will not be redeemable by either the Company or by the holders. Holders of the Series C Preferred Stock do not have any voting rights, including the right to elect any directors, other than the customary limited voting rights with respect to matters significantly and adversely affecting the rights and privileges of the Series C Preferred Stock.

As is the case with the Series B Preferred Stock, the fair market value of the Company’s common stock was higher than the conversion price of $3.25 per share of the Series C Preferred Stock on the date the Company made a firm commitment to issue the Series C Preferred Stock. Therefore, the Series C Preferred Stock also has a contingent beneficial conversion feature associated with it. However, since the conversion of the Series C Preferred Stock remains contingent upon the holder’s transfer of the securities to an unaffiliated third party with no specified date for its conversion to common stock, the Company will record the contingent beneficial conversion feature as an initial discount on Series C Preferred Stock and additional paid in capital, with a concurrent immediate accretion of the established discount and corresponding charge to retained earnings on the date the Series C Preferred Stock converts to common stock. The amount of the contingent beneficial conversion feature is approximately $0.2 million and will be recorded as described upon the original holder’s transfer of Series C Preferred Stock to an unaffiliated third party. Such transfer has not occurred as of September 30, 2010.

It should be noted that two investors in the Company’s March 2010 private placement have Board observation rights, while one of the two investors also has Board nomination rights.

Note 12. Regulatory Order and Written Agreement

On March 4, 2010, the FDIC and the DFI issued a Consent Order (the "Order") to the Bank that requires, among other things, the Bank to increase its capital ratios, reduce its classified assets and increase Board oversight of Management. The Board and Management are aggressively responding to the Order to ensure full compliance and have taken actions necessary to comply with the Order within the required time frames. Such actions include the completion of the capital raise discussed above which, following a contribution of a portion of the proceeds to the Bank, brought the Bank into compliance with the capital requirements of the Order. Additionally, a Written Agreement was entered into between the Company and the Federal Reserve Bank of San Francisco on March 4, 2010.

The following provides a summary of certain provisions in the Order as well as the Written Agreement. Please also refer to the Company’s current reports filed on Form 8-K with the SEC on March 10, 2010 and March 8, 2010, for a more complete description of the provisions of the Order and Written Agreement, respectively.

Consent Order

On February 26, 2010, the Bank stipulated to the issuance of the Order by the FDIC, its principal federal banking regulator, and the California Department of Financial Institutions (“DFI”) which requires the Bank to take certain measures to improve its safety and soundness. The Order was subsequently issued by the FDIC and DFI on March 4, 2010. The Bank’s stipulation to the issuance by the FDIC and the DFI of the Order resulted from certain findings in a report of examination resulting from an examination of the Bank conducted in September 2009 based upon financial and lending data measured as of June 30, 2009. In entering into the stipulation to entry of the Order, the Bank did not concede the findings or admit to any of the assertions in the report of examination (“ROE”).

Under the Order, the Bank is required to take certain measures as more fully discussed below. At September 30, 2010, the Bank believes it is in compliance with all components of the Order.

Among the corrective actions required are for the Bank to develop and adopt a plan to maintain the minimum capital requirements for a “well-capitalized” Bank, and to reach and maintain a Tier 1 leverage ratio of at least 10% and a total risked based capital ratio of 11.5% at the Bank level beginning 90 days from the issuance of the Order. Following the Company’s March 2010 private placement, $48.0 million was down-streamed to the Bank in the form of Tier I capital, bringing the Bank’s regulatory capital ratios above the required minimums set forth in the Order.

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Notes to Consolidated Financial Statements

Pursuant to the Order, the Bank must retain qualified management, must notify the FDIC and the DFI in writing when it proposes to add any individual to its Board of Directors or to employ any new senior executive officer, and must conduct an independent study of management and personnel structure of the Bank. A consultant was retained to complete the required management study. The Bank is in compliance with the Order’s timelines for completion of such study and implementation by the Board of a plan to address the findings of such study. As part of the capital raise, the Company and Bank received regulatory approval to add as a director of both the Bank and Company one of the principals of the investor in the transaction that owns approximately 14.4% of the outstanding voting shares of the Company. The addition of a director to the Company’s Board of Directors required an amendment to the Company’s bylaws to increase the range of the size of the board. The Company’s shareholders approved such an amendment at the June 10, 2010 Shareholder Meeting and the director was added to the Company’s Board effective June 23, 2010.

Under the Order the Bank’s Board of Directors must also increase its participation in the affairs of the Bank, assuming full responsibility for the approval of sound policies and objectives and for the supervision of all the Bank’s activities. The Board of Directors believes it has always provided appropriate oversight of the Bank, but has recently taken steps to reevaluate such oversight and enhance where appropriate the frequency and duration and the scope and depth of matters covered at its Board meetings in response to the current economic environment and concerns raised in the ROE. In direct response to the ROE, a new joint regulatory compliance committee was formed at both the Bank and Company levels to oversee the Bank’s and Company’s response to all regulatory matters, including the Order and the Written Agreement, discussed below. Detailed tracking of the Order’s requirements, and the Bank’s progress in responding thereto, is reviewed and reported at all such committee meetings, with regular reports then being provided by the committee to the full Board. Further, and prior to the issuance of the Order, the Board directed its Chairman, Michael Morris, to significantly increase his direct oversight of Management and involvement in Bank and Company affairs to ensure an appropriate response at both the Bank and Company to the concerns raised in the recent examination of the Bank.

The Order further requires the Bank to increase its Allowance for Loan Losses (“ALLL”), as of the date of the ROE, by $3.5 million and to review and revise its ALLL methodology. The Bank subsequently made provisions of approximately $19.3 million in the third and fourth quarters of 2009 and increased the ALLL by a net $4.2 million in the first quarter of 2010. The Bank has revised its Policy for determining the adequacy of the ALLL to include an assessment of market conditions and other qualitative factors. The Bank’s Policy otherwise continues to provide for a comprehensive determination of the adequacy of its ALLL which is to be reviewed promptly and regularly at least once each calendar quarter and be properly reported, and any deficiency in the allowance must be remedied in the calendar quarter it is discovered, by a charge to current operating earnings. As of the date of this report the Bank is in compliance with this provision of the Order.

With respect to classified assets as of the date of the ROE, the Order also requires the Bank to charge-off or collect all assets classified as “Loss” and one-half of the assets classified as “Doubtful,” and within 180 days of the Order to reduce its level of assets classified as “Substandard” to no more than the greater of $50.0 million or 50% of Tier 1 capital plus the ALLL. As of December 31, 2009, the Bank met the requirement to charge-off or collect all assets classified as “Loss” and one-half of the assets classified as “Doubtful” as of the date of the ROE. At September 30, 2010, the Bank has met the requirement to reduce assets classified as “Substandard” as of the date of the ROE to no more than the greater of $50.0 million or 50% of Tier 1 capital plus the ALLL.

The Order requires that the Bank develop or revise, adopt and implement a plan, which must be approved by the FDIC and DFI, to reduce the amount of Commercial Real Estate loans extended, particularly focusing on reducing loans for construction and land development. At September 30, 2010, the Bank has reduced its concentrations for Commercial Real Estate and construction and land development to within guidelines acceptable by the Order. In addition, the Bank is to develop a plan for reducing the number of “watch list” credits to an acceptable level, and develop or revise its written lending and collection policies to provide more effective guidance and control over the Bank’s lending function. At September 30, 2010, the Bank has in place a plan to comply with this provision of the Order.

The Order restricts the Bank from taking certain actions without the prior written consent of the FDIC and the DFI, including paying cash dividends, and from extending additional credit to certain types of borrowers. The Bank has not paid cash dividends since the first quarter of 2008. In addition, the Bank has put processes and controls in place to ensure extensions of credit, directly or indirectly, are not granted to those who are related to borrowers of loans charged-off or classified as “Loss”, “Substandard” or “Doubtful” in the ROE. The Bank has also acknowledged that neither the loan committee nor the Board of Directors will approve any extension to a borrower classified “Substandard” or “Doubtful” in the ROE without first collecting all past due interest in cash.

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Notes to Consolidated Financial Statements

The Order further requires the Bank to develop or revise, adopt and implement a revised liquidity policy, and to adopt a contingency funding plan to adequately address contingency funding sources and appropriately reduce contingency funding reliance on off-balance sheet sources. The Bank has revised its current liquidity policy and contingency funding plan.

The Order also requires that the Bank prepare and submit a revised business plan, that is to include a comprehensive budget, and a 3 year strategic plan, and to further revise its investment policy. The Bank has since prepared a comprehensive budget and revised the investment policy and is in the process of developing a revised business plan and 3 year strategic plan.

Although the Company believes it is in full compliance with all provisions of the Order as of the date of this report, ultimate determination of compliance will be determined by the FDIC and DFI in connection with their examination of the Bank and other regulatory processes.

Written Agreement

On March 4, 2010, the Company entered into a written agreement with the FRB (the “Written Agreement”), which requires the Company to take certain measures to improve its safety and soundness. Under the Written Agreement, the Company is required to develop and submit for approval, a plan to maintain sufficient capital at the Company and the Bank within 60 days of the date of the Written Agreement. The Written Agreement further provides, among other things, that the Company shall not: declare or pay dividends without prior approval of the FRB, take dividends from the Bank, make any distribution of interest, principal or other sums on subordinated debt or trust preferred securities, incur, increase, or guarantee any debt. The Company believes it is currently in compliance with all requirements of the Written Agreement, including an update to its capital plan. The Company has updated its cash flow projections for 2010 and has provided that information to the FRB.

The forgoing discussion of the Order and Written Agreement are qualified in their entirety by reference to the complete text of the Order and Written Agreement, which can be found on the Current Reports on Form 8-K filed March 10, 2010, and March 8, 2010, respectively.

Note 13. Junior Subordinated Debentures

On June 8, 2010, the Company repurchased $5.0 million in face amount trust preferred securities issued by Heritage Oaks Capital Trust III, and the related $5.2 million junior subordinated debentures issued by the Company. The repurchase resulted in a pre-tax gain of approximately $1.7 million, recognized during the three months ended June 30, 2010. The repurchase was made pursuant to the non-objection of the Federal Reserve Bank of San Francisco and approval of the United States Treasury Department.

In the second quarter of 2010 the Company elected to defer interest payments on $8.2 million junior subordinated debentures to comply with the terms of the Written Agreement entered into between the Company and the Federal Reserve Bank of San Francisco. As a result the Company has accrued for but has not paid approximately $89 thousand in interest payments on these debentures, as of September 30, 2010, for the second and third quarter 2010 payments due on these debentures. For more information concerning the Written Agreement, please refer to Note 12. Regulatory Order and Written Agreement of these consolidated financial statements. For such time as the Company continues to the deferral of interest, it will be prevented from, among other things, paying dividends on its preferred and common stock.

Note 14. Reclassifications

Certain amounts in the 2009 financial statements have been reclassified to conform to the 2010 presentation.

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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: the ongoing financial crisis in the United States, including the continuing downturn in the California real estate market, and the response of the federal and state government and our regulators thereto, general economic 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 impact of the recent capital raise to support the Company’s business, as well as economic, political and global changes arising from the war on terrorism, increased profitability, continued growth, the Company’s beliefs as to the adequacy of its existing and anticipated allowance for loan losses, beliefs and expectations about, and requirements to comply with the terms of Consent Order and Written Agreement issued by regulatory authorities having oversight of the Company’s and Bank’s operations, and financial policies of the United States government. (Refer to the Company’s December 31, 2009 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.

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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 as of and for the three and nine month periods ending September 30, 2010 and 2009. 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 15 branch bank serving San Luis Obispo and Santa Barbara Counties. In 1994, the Company acquired all of the outstanding common stock of the Bank in a holding company formation transaction.

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

In September 2007, the Company formed Heritage Oaks Capital Trust III (“Trust III”). Trust III is a statutory business trust formed under the laws of the State of Delaware and is a wholly-owned, non-financial, non-consolidated subsidiary of the Company. In June 2010 the Company re-purchased all the outstanding securities related to Trust III and plans to dissolve Trust III in the fourth quarter of 2010.

On October 12, 2007, the Company acquired Business First National Bank (“Business First”). Business First was merged with and into Heritage Oaks Bank, a wholly owned subsidiary of the Company. In connection with the acquisition, two additional branches were added to the Bank’s network. For additional information regarding this acquisition, please see Note 23 to the consolidated financial statements of the Company’s 2008 annual report, which was filed on Form 10-K.

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 are 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.

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Management’s Discussion and Analysis

Executive Summary

For the three and nine months ended September 30, 2010, the Company reported a net loss applicable to common shareholders of approximately $11.3 million and $22.6 million, respectively. In the same periods ended a year earlier, the Company reported a net loss applicable to common shareholders of approximately $5.6 million and $4.2 million, respectively. Net loss per diluted common share was $0.45 for the third quarter of 2010, compared to net loss of $0.73 per diluted common share in the same period ended a year earlier. For the first nine months of 2010, the net loss per diluted common share was $1.54 compared to net loss per diluted common share of $0.56 for the same period ended a year earlier.

Operating results for the third quarter of 2010 were significantly impacted by a $10.5 million valuation allowance the Company recorded for a portion of its deferred tax assets. Please see Note 5. Deferred Tax Assets, of the conslolidated financial statements, filed on this Form 10-Q for additional information related to the valuation allowance established for deferred tax assets. Exclusive of this charge, operating results for the third quarter of 2010, as outlined below, showed significant improvement when compared to prior year results, as the Company experienced measured improvement in asset quality. However, the results for the first nine months of 2010, exclusive of the valuation allowance established for a portion of the Company’s deferred tax assets, when compared to the same period ended a year earlier reflect the impact of a very challenging first six months of 2010, resulting in higher year over year loan loss provisions.

Third quarter 2010 and year to date operating results through September 30, 2010, exclusive of the $10.5 million valuation allowance recorded for a portion of the Company’s deferred tax assets, were positively impacted by greater net interest income and non-interest income as compared to the same periods a year earlier. Positive quarterly and year-to date impacts to net interest income are attributable to the increased interest income generated by the securities portfolio and reductions in the Company’s cost of interest bearing liabilities. Current quarter and year to date increases of non-interest income, as compared to the same periods a year earlier are primarily attributable to increased gains on sales of investment securities, mortgage origination income, and a reduction in losses on sale of OREO. Increases in non-interest income for the first nine months ended September 30, 2010 as compared to the same prior year period are also significantly elevated due to the $1.7 million pre-tax gain the Company recognized from the extinguishment of $5.0 million in junior subordinated debentures in June 2010.

The provision for loan losses continues to have a significant negative effect on year to date operating results through September 30, 2010; current year to date loan loss provisions were 76.4% higher than those recorded for the same period a year earlier. Increased provisions for loan losses can be attributed to downgrades in the loan portfolio and current year charge-offs related to the continued effort to work through the troubled asset portfolio. However, the Company recorded 54.9% less in provision for loan losses during the third quarter of 2010 as compared with the same quarter a year earlier, demonstrating a deceleration in the amount of required provisions for loan losses. As of September 30, 2010, the allowance for loan losses represented 3.20% of total gross loans.

Non-interest expenses decreased for the quarter ended September 30, 2010, as compared to the third quarter of 2009, primarily as a result of decreases in OREO related write-downs and sales costs. This positive impact on non-interest expense was augmented by decreases in data processing expenses and FDIC insurance premiums, but was significantly offset by increases in salaries and benefits, and, to a lesser extent, increases in occupancy costs. Non-interest expense for the nine months ended September 30, 2010 increased as compared to the same period ended a year earlier primarily due to increases in salaries and benefits, FDIC insurance premiums and occupancy costs; all offset partially by decreases in OREO related write-downs and sales costs.

Liquidity continued to remain strong during the third quarter of 2010. The Company reported a liquidity ratio, the ratio of liquid assets not pledged for collateral and other purposes to deposits and other liabilities, of 31.89% at September 30, 2010, compared to 20.50% and 19.65% reported at December 31, 2009, and September 30, 2009, respectively. The proceeds from the March 2010 private placement, a $20.2 million or 2.6% year to date increase in total deposits, in conjunction with reduced loan demand, contributed significantly to the rise in on-balance sheet liquidity.

The following provides a summary of operating results for the three and nine month periods ended September 30, 2010 and 2009:

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Management’s Discussion and Analysis

For the three and nine months ended September 30, 2010 interest income totaled approximately $12.7 million and $38.3 million. When compared to the same three and nine month periods ended a year earlier, this represents increases of approximately $0.8 million and $2.3 million, respectively. The increase in interest income was primarily driven by an increase in the average balance of the Company’s investment portfolio which increased by $108.7 million and $93.2 million, respectively, for the three and nine months ended September 30, 2010, as compared to the same periods ended a year earlier. Increases within this category can be attributed in large part to the investment of excess liquidity stemming from significant year over year deposit growth as well as funds received in the Company’s March 2010 private placement. Increases in interest income from the investment portfolio were augmented by increases in interest income from the loan portfolio, despite a $16.8 million decrease in average loan balances, for the three months ended September 30, 2010 as compared to the same period ended a year earlier. This was primarily a result of a decrease of interest reversals on loans transferred to non-accrual status during the quarter ended September 30, 2010 as compared to the third quarter of 2009. Interest income from loans also increased for the nine months ended September 30, 2010 as compared to the same period ended a year earlier due to the positive impact of an increase in average loans of $12.4 million, which was partially offset by the negative impact of higher levels of forgone interest.

For the three and nine months ended September 30, 2010, interest expense totaled approximately $1.9 million and $6.4 million, respectively. When compared to the same three and nine month periods ended a year earlier, this represents a decrease in interest expense of approximately $0.7 million and $0.9 million, respectively. Management’s continued focus on decreasing funding costs contributed significantly to the year over year declines within this category. The cost of interest bearing deposits declined 60 and 39 basis points for the three and nine month periods ended September 30, 2010 when compared to that reported for the same three and nine month periods ended a year earlier.

Net interest income for the three and nine months ended September 30, 2010 totaled approximately $10.8 million and $31.9 million. Net interest income increased approximately $1.6 million and $3.3 million from that reported during the same three and nine month periods ended a year earlier. Year over year changes in net interest income can be attributed in large part to the items mentioned in the preceding paragraphs.

Non-interest income totaled approximately $2.5 million and $7.7 million for the three and nine month periods ended September 30, 2010, representing an increase of approximately $0.9 million and $3.0 million, respectively when compared to the same periods ended a year earlier. Significant items contributing to the increase of non-interest income for both the three and nine months ended September 30, 2010 as compared to the same periods ended a year earlier were the increases of gains on sale of investment securities, greater amounts of mortgage origination fee income, and reductions in losses on disposition of OREO, which offset decreases in service charges on deposit accounts. The most significant component of the year to date increase in non-interest income, however, was the $1.7 million pre-tax gain on the extinguishment of $5.0 million in junior subordinated debentures during the second quarter of 2010.

Non-interest expense totaled approximately $9.9 million and $27.6 million for the three and nine months ended September 30, 2010, respectively. These amounts when compared to those reported for the same periods ended a year earlier represent a decrease of approximately $0.4 million and an increase of $1.9 million, respectively. The year over year decline for the third quarter of 2010 can be attributed in large part to a decrease in both write-downs of OREO to fair market value and the costs associated with maintaining such assets, and to a lesser extent, reductions in amortization of the core deposit intangible (“CDI”) and data processing charges. Increased salaries and benefits costs accounted for the majority of the increase in non-interest expenses for the nine months of 2010, and offset a significant portion of the decrease for the three months ended, September 30, 2010 as compared to the same periods ended a year earlier. Salaries and benefits increases on a quarterly and year to date basis resulted from expansion in the Company’s management team, increases in insurance benefit premiums, and adjustments in accrued compensated absences. Other year to date increases to non-interest expense were driven by increases in FDIC insurance premiums and occupancy expenses. For more information related to non-interest expenses, please see “Non-Interest Expenses” of this Discussion and Analysis.

The efficiency ratio was 77.90% for the third quarter of 2010, compared to 95.12% in the third quarter of 2009. Year over year, the efficiency ratio decreased from 77.02% for the nine months ending September 30, 2009 to 74.45% for the nine months ended September 30, 2010 and was positively impacted due to an increase in net interest income during 2010 which more than offset increases in non-interest expenses.

The following provides a summary for significant year to date changes in financial condition balances as of September 30, 2010:

At September 30, 2010, gross loan balances were approximately $672.3 million, approximately $54.8 million or 7.5% lower than that reported at December 31, 2009. Contributing to the year to date decline in loan balances was the receipt of approximately $15.7 million in principal payments on non-accruing loans, $12.1 million in transfers to foreclosed collateral and $20.3 million in charge-offs. The remaining year to date decline in gross loans can be attributed to several large pay-downs during the first nine months of 2010 in conjunction with scheduled amortization of balances in the absence of significant new loan originations. The lower volume of loan originations relative to historical periods can be attributed in part to lower demand for credit as well as the Company becoming more selective with respect to the types of loans it chooses to originate. See also “Loans” under “Financial Condition” of this Discussion and Analysis for additional information regarding the Company’s loan portfolio.

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Management’s Discussion and Analysis

At September 30, 2010, total deposits were approximately $795.6 million, approximately $20.2 million or 2.6% higher than that reported at December 31, 2009. Deposits, exclusive of brokered deposits were approximately $794.8 million or $30.5 million higher than that reported at December 31, 2009. Increases in core deposit balances allowed the Company to rely less on brokered deposits for funding. At September 30, 2010 brokered deposit balances totaled approximately $0.9 million and represented 0.1% of total deposits. This compares to $11.2 million or 1.5% at December 31, 2009. See also “Deposits and Borrowed Funds” under “Financial Condition” of this Discussion and Analysis for information regarding the Company’s deposit liabilities.

At September 30, 2010, borrowings from the FHLB were $55.0 million, and decreased $10.0 million from that reported at December 31, 2009. The average rate paid on borrowings with the FHLB for the three and nine months ended September 30, 2010 was 0.73% and 0.64%, respectively. This compares to the 0.63% and 0.81% reported for the same three and nine month periods ended a year earlier.

Investment securities totaled approximately $202.2 million, approximately $81.0 million greater than that reported at December 31, 2009. The year to date increase in the portfolio can be attributed to purchases the Company made to maximize the yield on earning assets in the absence of significant new loan originations. For additional information on the Company’s investment securities portfolio, please see “Investment Securities and Other Earning Assets” of this Discussion and Analysis.

Federal Funds sold and interest bearing due from balances totaled approximately $40.4 million at September 30, 2010, representing an increase of approximately $19.0 million over that reported at December 31, 2009. Increased balances within this category are attributable in large part to approximately $20.2 million in deposit growth experienced during the first nine months of 2010 as well as proceeds the Company received related to its March 2010 private placement. See also “Investment Securities and Other Earning Assets” of this Discussion and Analysis for additional information regarding Federal Funds sold and interest bearing due from balances.

The following provides an overview of asset quality as of September 30, 2010:

At September 30, 2010, the balance of non-performing loans was approximately $26.8 million or $8.3 million and $11.4 million lower than that reported at June 30, 2010 and December 31, 2009, respectively. As of September 30, 2010 the balance of non-performing loans as a percentage of total gross loans was 3.98% compared to the 5.03% and 5.26% reported as of June 30, 2010 and December 31, 2009, respectively. Contributing to the year to date decrease in non-performing loans was the receipt of approximately $15.7 million in principal payments on non-accruing balances, transfers to foreclosed collateral totaling $12.1 million and charge-offs of approximately $20.3 million. Contributing further to the year to date decrease in non-accruing loans was the return of approximately $3.7 million in balances to accruing status following the Company’s efforts to bring resolution to problem credits. These reductions were offset by approximately $40.4 million in balances that transferred to non-accruing status during the first nine months of 2010. Please see “Non-Performing Assets” of this Discussion and Analysis for a more complete discussion of the loans the Company has placed on non-accrual status.

At September 30, 2010, the allowance for loan losses totaled approximately $21.6 million, representing 3.20% of total gross loans. This compares to the $14.4 million or 1.97% of total gross loans reported at December 31, 2009. Provisions for loan losses during the three and nine months ended September 30, 2010 totaled approximately $4.4 million and $25.7 million, respectively. Provisions for loan losses declined approximately $5.4 million, and increased approximately $11.1 million for the three and nine month periods ended September 30, 2010, when compared to the same respective periods ended in 2009. See also “Provision for Loan Losses” of this Discussion and Analysis for a more complete discussion regarding loan loss provisions.

Charge-offs during the three and nine month periods ended September 30, 2010 totaled approximately $5.1 million and $20.3 million, respectively. Net charge-offs during the three and nine month periods ended September 30, 2010 totaled approximately $5.0 million and $18.5 million, respectively. Net charge-offs to average gross loans were 0.71% and 2.58% for the three and nine month periods ended September 30, 2010, respectively. This compares to 0.70% and 1.29% reported for the same three and nine month periods ended a year earlier. Please see “Allowance for Loan Losses” of this Discussion and Analysis for additional information related to the charge-offs.

Heritage Oaks Bancorp | - 34 -

Management’s Discussion and Analysis

OREO balances totaled approximately $9.0 million at September 30, 2010, an increase of approximately $8.1 million from that reported at December 31, 2009. As previously mentioned, the Company transferred approximately $12.1 million to OREO in the first nine months of 2010. OREO dispositions totaled approximately $3.1 million and write-downs of OREO totaled $0.9 million in first nine months of 2010.

Recent Developments

The Bank is currently in the middle of an ongoing regulatory examination. The results of this examination are not known at the time of this filing. The results of this examination, when determined, may have an impact on the financial results of the Bank and the Company. Although the Company believes it is in full compliance with the terms of the Order, as discussed in Note 12 of the consolidated financial statements filed on this Form 10-Q, compliance will be determined by the FDIC and DFI in connection with their examination of the Bank.

Dividends and Stock Repurchases

During the first nine months of 2010, the Company paid approximately $0.3 million in dividends on its Series A Senior Preferred Stock issued to the U.S. Treasury under the CPP. In the second quarter of 2010 the Company was required to defer dividend payments on its Series A Senior Preferred Stock to comply with the terms of the Written Agreement entered into between the Company and the Federal Reserve Bank of San Francisco. See also Note 11. Preferred Stock, of the consolidated financial statements filed on this form 10-Q for additional information about dividends on the Company’s Series A Senior Preferred Stock. For more information concerning the Written Agreement, please refer to Note 12. Regulatory Order and Written Agreement of the consolidated financial statements filed on this Form 10-Q.

The Company paid no dividends on or made repurchases of its common stock during the first nine months of 2010 or during the entire year of 2009.

Heritage Oaks Bancorp | - 35 -

Management’s Discussion and Analysis

Selected Financial Data

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

	For the quarters ended,
(dollars in thousands except per share data)	09/30/10			06/30/10			03/31/10			12/31/09			09/30/09			06/30/09			03/31/09			12/31/08

Return on average assets		-4.29	%		-2.32	%		-0.56	%		-1.43	%		-2.30	%		0.23	%		0.54	%		-0.63	%

Return on average equity		-32.20	%		-17.35	%		-5.70	%		-15.27	%		-22.54	%		2.20	%		6.04	%		-6.93	%

Return on average common equity		-40.70	%		-55.46	%		-10.93	%		-22.05	%		-31.14	%		1.44	%		6.21	%		-6.93	%

Average equity to average assets		13.32	%		13.36	%		9.88	%		9.35	%		10.18	%		10.68	%		8.95	%		9.06	%

Average common equity to average assets		10.88	%		6.91	%		6.57	%		7.14	%		7.87	%		8.26	%		8.61	%		9.06	%

Net interest margin		4.56	%		4.69	%		4.43	%		4.81	%		4.34	%		4.91	%		5.03	%		5.04	%

Efficiency ratio*		77.90	%		68.86	%		76.88	%		70.84	%		95.12	%		70.02	%		66.71	%		66.43	%

Average loans to average deposits		87.99	%		91.82	%		93.67	%		93.45	%		98.20	%		103.58	%		112.39	%		109.95	%

Net (loss) / income	$	(10,903	)	$	(5,835	)	$	(1,339	)	$	(3,416	)	$	(5,242	)	$	507		$	1,102		$	(1,254	)

Net (loss) / income available to common shareholders	$	(11,260	)	$	(9,644	)	$	(1,690	)	$	(3,767	)	$	(5,594	)	$	257		$	1,091		$	(1,254	)

(Loss) / Earnings Per Common Share:
Basic	$	(0.45	)	$	(0.86	)	$	(0.22	)	$	(0.48	)	$	(0.73	)	$	0.03		$	0.14		$	(0.16	)
Diluted	$	(0.45	)	$	(0.86	)	$	(0.22	)	$	(0.48	)	$	(0.73	)	$	0.03		$	0.14		$	(0.16	)
Weighted Average Outstanding Shares:
Basic		25,004,479			11,250,989			7,717,194			7,704,060			7,699,377			7,696,027			7,689,317			7,660,342
Diluted		25,004,479			11,250,989			7,717,194			7,704,060			7,699,377			7,866,962			7,824,377			7,660,342

* The efficiency ratio is defined as total non interest expense as a percent of the combined net interest income plus non interest income, exclusive of gains and losses on the sale of investment securities, other real estate owned, SBA loans, FF&E, extinguishment of debt and OTTI impairment losses.

Local Economy

The economy in the Company’s primary market area (San Luis Obispo and Santa Barbara Counties) 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, the City of Santa Maria (in Northern Santa Barbara County), and the City of Santa Barbara totaled approximately 267,000, 85,000, and 86,000 respectively, according to the most recent economic data provided by the U.S. Census Bureau. The moderate climate allows a year round growing season in the local economy’s agricultural sector. Vineyards and cattle ranches also contribute largely to the local economy. The Central Coast’s leading agricultural industry is the production of wine grapes. Vineyards in production have grown significantly over the past several years throughout the Company’s service area. Further, access to numerous recreational activities and destinations 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. The economy in the Company’s primary markets of San Luis Obispo and Santa Barbara counties has not been immune to the current downturn in national and state economic conditions. Weakened economic conditions have resulted in, among other things, increased unemployment, increased vacancy rates, and lower occupancy rates in the hospitality industry within the Company’s primary markets. However, the abundant tourism that has developed over the past decade in the Company’s market area, especially in the wine industry and coastal communities, has provided support for the local economy in previous economic downturns and has, to some degree, provided support in the current economic environment.

Heritage Oaks Bancorp | - 36 -

Management’s Discussion and Analysis

The last two years have proven to be challenging not only on the national level, but within the state of California and more specifically the Company’s primary market area. As the real estate market and general economic conditions have continued to wane throughout the last two years, the ability of borrowers to satisfy their obligations to the financial sector has languished. Although the Company’s primary market area has historically witnessed a more stable level of economic activity, the weakened state of the real estate market in conjunction with a decline in economic activity in the Company’s primary market has negatively impacted the credit quality of the loan portfolio over the last two years. Recent indications show the unemployment rate within California to be approximately 12.4%. Within the Company’s primary market area, recent indications show the unemployment rate within San Luis Obispo and Santa Barbara major metropolitan areas to be approximately 10.3% and 8.9%, respectively. Additionally, according to the most recent data available to the Company in regard to hotel occupancy rates, published by Smith Travel Research in June 2010, hotel occupancy rates showed a year over year decline of 3.9% and 0.1% for Paso Robles/San Luis Obispo and Santa Barbara/Santa Maria, respectively. For the State of California, hotel occupancy rates showed a year over year increase of 5.7%.

Real estate prices have fallen significantly in California and within the Company’s market area from the highs seen during 2006 and 2007. Recent information provided by DataQuick Information Systems indicates that housing prices in San Luis Obispo and Santa Barbara counties have declined in excess of 38% from the highs seen in 2006 and 2007. Prices in some of the largest cities in the Company’s market area such as: San Luis Obispo, Paso Robles, Santa Barbara, and Santa Maria have experienced year over year price variances of approximately -4%, -1%, 17%, and -6%, respectively as of August 2010. It should be noted that although changes in local median home prices typically indicate home price appreciation and depreciation, price changes may also reflect shifts in the composition of housing market activity. Therefore, some of the variations in median home prices as of August 2010 may have been impacted by compositional changes in housing demand. Real estate sales in the Company’s market area have remained relatively stable, and can be attributed in part to sales of distressed properties, and the work through of any additional supply added to the market in recent years during the economic downturn.

Although prices in the Company’s market area remain well below the highs witnessed in 2006 and 2007, a lack of oversupply in the Company’s market relative to other areas of California, desirable climate, and close proximity to popular tourist destinations, for both San Luis Obispo and Santa Barbara Counties have resulted in lower percentage declines in prices for the local real estate market, relative to other areas of California.

Commercial real estate prices in the Company’s primary markets have also come under some pressure in the current economic downturn, although not to the extent witnessed in some other areas of California. The most current data available to the Company indicates vacancy rates in the retail, office and manufacturing sectors of the Company’s primary market area to be 3.0%, 6.1% and 5.4%, respectively as of the fourth quarter of 2009. This compares to vacancy rates of 1.4%, 3.5% and 2.3% for the same respective categories in 2008.

As economic conditions continue to wane, and as the level of unemployment continues to rise, conditions within the Company’s primary market may be negatively impacted above and beyond what the Company has seen thus far. Additional job losses and any prolonged decline in economic activity may further impact the borrowers to whom the Company has extended credit, which may further impact the Company’s operating results and financial condition.

Critical Accounting Policies

The Company’s significant accounting policies are set forth in the 2009 Annual Report, Note 1 of the 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.

Loans and Interest on Loans

Loans receivable that Management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding unpaid principal balances reduced by any charge-offs of specific valuation allowances and net of any deferred fees or costs on originated loans, or unamortized premiums or discounts on purchased loans.

Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment in yield over the life of the related loan.

Heritage Oaks Bancorp | - 37 -

Management’s Discussion and Analysis

Loans on which the accrual of interest has been discontinued are designated as non-accruing loans. The accrual of interest on loans is discontinued when principal and/or interest is past due 90 days based on contractual terms of the loan and/or when, in the opinion of Management, there is reasonable doubt as to collectability unless such loans are well collateralized and in the process of collection. When loans are placed on non-accrual status, all interest previously accrued but not collected is reversed against current period interest income. Interest income generally is not recognized on specific non-accruing loans unless the likelihood of further loss is remote. Interest payments received on such loans are applied as a reduction to the loan principal balance. Interest accruals are resumed on such loans only when they are brought current with respect to interest and principal and when, in the judgment of Management, all remaining principal and interest is estimated to be fully collectible, there has been at least six months of sustained repayment performance since the loan was placed on non-accrual and/or Management believes, based on current information, that such loan is no longer impaired.

The Company considers a loan to be impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Measurement of impairment is based on the expected future cash flows of an impaired loan which are discounted at the loan’s original effective interest rate, or measured by reference to an observable market value, if one exists, or the fair value of the collateral for a collateral-dependent loan. The Company selects the measurement method on a loan-by-loan basis except that collateral-dependent loans for which foreclosure is probable are measured at the fair value of the collateral. The Company recognizes interest income on impaired loans based on its existing methods of recognizing interest income on non-accrual loans. All loans are generally charged-off at such time that it is highly certain a loss has been realized.

Allowance for Loan Losses

The allowance for loan losses is maintained at a level which, in Management's judgment, is adequate to absorb credit losses inherent in the loan portfolio as of the balance sheet date. The amount of the allowance is based on Management's evaluation of the collectability of the loan portfolio, including the nature and volume of the portfolio, credit concentrations, trends in historical loss experience, the level of certain classified balances and specific impaired loans, and economic conditions and the related impact on specific borrowers and industry groups. The allowance is increased by provisions for loan losses, which are charged to earnings and reduced by charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses. Because of uncertainties inherent in the estimation process, Management’s estimate of credit losses inherent in the loan portfolio and the related allowance may change.

As mentioned, loans are considered impaired if, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. In certain instances the Company may work with the borrower to modify the terms of the loan agreement or otherwise restructure the loan in a way that would allow the borrower to continue to perform under the modified terms of the loan agreement. Loans such as these are considered impaired and require the Company to measure the amount of impairment, if any, at the time the loan is restructured. 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 less the cost to sell such 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. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows.

As mentioned, 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 losses and the associated provision for loan losses.

Other Real Estate Owned

Real estate and other property acquired in full or partial settlement of loan obligations is referred to as other real estate owned (“OREO”). OREO is originally recorded in the Company’s financial statements at fair value less any estimated costs to sell. When property is acquired through foreclosure or surrendered in lieu of foreclosure, the Company measures the fair value of the property acquired against its recorded investment in the loan. If the fair value of the property at the time of acquisition is less than the recorded investment in the loan, the difference is charged to the allowance for loan losses. Any subsequent fluctuations in the fair value of OREO are recorded against a valuation allowance for foreclosed assets, established through a charge to non-interest expense. All related operating or maintenance costs are charged to non-interest expense as incurred. Any subsequent gains or losses on the sale of OREO are recorded in other income or expense as incurred.

Heritage Oaks Bancorp | - 38 -

Management’s Discussion and Analysis

Appraisals for Collateral Dependent Loans

Once a loan has been funded, the Company has a policy to perform an annual review of the borrower’s financial condition and of any real estate securing the loan. This review includes, among other things, a physical inspection of the real estate securing the loan, an analysis of any related rent rolls, an analysis of all borrower and guarantor tax returns and financial statements. This information is used internally by the Company to validate all covenants and the risk grade assigned to the loan. If during the review process the Company learns of additional information that would suggest that the value of the collateral may be impaired from the original underwriting of the loan, or the most recent appraisal, an additional independent appraisal of the collateral is requested. If based on the updated appraisal information it is determined the value of the collateral is impaired and the Company no longer expects to collect all previously determined amounts related to the loan as stipulated in the loan’s original agreement, the Company typically moves to establish a valuation allowance for such loans or charge-off such differences. Once a loan is deemed to be impaired and/or the loan was downgraded to substandard status, the loan becomes the responsibility of the Company’s Special Assets department, which provides more diligent oversight of problem credits. This oversight includes, among other things, a review of all previous appraisals of collateral securing such loans and determining in the Company’s best judgment if those appraisals still represent the current fair value of the loan. Additional appraisals may be ordered at this time if deemed necessary.

Securities Available for Sale

In accordance with U.S. GAAP, securities are classified in three categories and accounted for as follows: debt and mortgage-backed 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 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 unrealized gains and losses, net of applicable taxes, reported in a separate component of stockholders' equity. The fair value of most securities that are designated available for sale are based on quoted market prices. If quoted market prices are not available, fair values are extrapolated from the quoted prices of similar instruments or through the use of other observable data supporting a valuation model. Gains or losses on sales of investment securities are determined on the specific identification method. Premiums and discounts are amortized or accreted using the interest method over the expected lives of the related securities.

Declines in the fair value of individual held-to-maturity and available-for-sale securities below their cost that are other than temporary result in write-downs of individual securities to their fair value. The related write-downs are included in earnings as realized losses. In estimating other-than-temporary impairment losses, Management considers: (1) the length of time the security has been in an unrealized loss position, (2) the extent to which the security’s fair value is less than its cost, (3) the financial condition of the issuer, (4) any adverse changes in ratings issued by various rating agencies, (5) the intent and ability of the Company to hold such securities for a period of time sufficient to allow for any anticipated recovery in fair value and (6) in the case of mortgage related securities, current cash flows, credit enhancements, loan-to-values, credit scores, delinquency and default rates.

Goodwill and Other Intangible Assets

As discussed in the 2009 Annual Report, Note 1 of the consolidated financial statements, which was filed on Form 10-K, the Company assess goodwill and other intangible assets each year for impairment. The Company’s assessment at December 31, 2009, pursuant to its Goodwill Impairment Testing Policy, was performed with the assistance of an independent third party and resulted in no impairment.

Deferred Tax Assets

Deferred income taxes reflect the tax effect of temporary differences between the financial statement carrying amounts and the corresponding tax basis of assets and liabilities. The Company uses an estimate of future earnings to support its position that the benefit of its deferred tax assets will be realized. If future income should prove non-existent or less than the amount of the deferred tax assets within the tax years to which they may be applied, the asset may not be realized and a valuation allowance may be established and the Company’s net income will be reduced. The Company performed an in depth analysis of its deferred tax assets to determine if the current carrying value would be realized in future periods during the third quarter of 2010. Based on the Company’s analysis it determined that approximately $10.5 million of its deferred tax assets did not meet the “more likely than not” standard for realizability as of September 30, 2010. Therefore the Company established a valuation allowance for this portion of its deferred tax assets. Please see Note 5. Deferred Tax Assets of the consolidated financial statements, filed on this Form 10-Q for additional information related to its deferred tax assets and the related valuation allowance.

Heritage Oaks Bancorp | - 39 -

Management’s Discussion and Analysis

Results of Operations

The Company’s operating results for the three months ended September 30, 2010 when compared to the same period ended a year earlier were significantly impacted by higher provisions for income taxes, due to a $10.5 million valuation allowance established for a portion of the Company’s deferred tax assets. Exclusive of this charge, operating results for the third quarter of 2010 showed significant improvement due to a reduction in the provisions for loan losses. Provisions for loan losses during the three months ended September 30, 2010 totaled approximately $4.4 million, representing a decrease of approximately $5.4 million from that reported in the same period ended a year earlier. Provisions for loan losses made during the first nine months of 2010 totaled approximately $25.7 million and increased by $11.1 million when compared to the same period ended a year earlier; therefore the Company’s operating results on a year to date basis, remain below that experienced through September 30, 2009. Net charge-offs were similar for the three month periods ended September 30, 2010 and 2009, however the amount of provision recorded during the third quarter of 2009 was significantly larger than that recorded during the third quarter of 2010 due to the need to increase the allowance for loan losses as a percentage of gross loans to an acceptable level. Net charge-offs for 2010 on a year to date basis were nearly double the amount recorded for the first nine months of 2009, and when combined with increases in historical loan loss rates, continued weakness in the local and national economy and deterioration in asset quality, necessitated additional provisions for loan losses. Please see “Provision for Loan Losses” of this Discussion and Analysis for additional information related to provision for loan losses.

Forgone interest on non-accrual loans continues to be a significant strain on interest income on a year to date basis, though this trend is stabilizing due to a deceleration in the volume of new non-accrual loans. Total forgone interest related to impaired loans, which includes (1) the initial accrued interest reversal when a loan is transfered to non-accrual status, and (2) interest lost prospectively for the period of time a loan is on non-accrual status and lost interest due to restructuring terms below original note terms, was approximately $0.7 million and $2.4 million during the three and nine months ended September 30, 2010.

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 net 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 Federal Funds and Prime interest rates. Contributing significantly to an asset sensitive balance sheet is a relatively 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.

However, in the last two years interest rates have fallen to unprecedented levels and as a result a significant portion of loans in the Company’s loan portfolio are currently at their floors. Given that current interest rates are considerably lower than most floors in the loan portfolio, the Company would need to see a notable rise in interest rates before the overall yield on the portfolio would begin to rise. Additionally, as a result of promotions over the last two years designed to attract lower cost core deposits, the Company was able to significantly increase the level of floating rate liabilities in the form of money market and short term certificate accounts, bringing the balance sheet to a more neutral position regarding interest rate sensitivity. This was instrumental in mitigating substantial year over year declines in the net interest margin as a result of dramatic declines in the overnight Federal Funds and Prime rates during 2008 which are still in place as of September 30, 2010.

For the three and nine months ended September 30, 2010 and 2009, the net interest margin was 4.56%, 4.56%, 4.34%, 4.75%, respectively. This represents an increase of 22 and a decline of 19 basis points when compared to that reported for the same periods ended a year earlier. As mentioned, forgone interest related to loans the Company placed on non-accrual and rate concessions on TDRs negatively impacted the net interest margin in 2010, although less so in the third quarter of 2010 as compared to the third quarter of 2009. For the third quarter and first nine months of 2010 interest reversals (related to loans placed on non-accrual during the period) negatively impacted the net interest margin by approximately 8 and 6 basis points. Total forgone interest negatively impacted the net interest margin by approximately 32 and 33 basis points for the third quarter and the first nine months of 2010, respectively. The shift in interest earning asset mix away from higher yielding loans to lower yielding securities has also begun to negatively impact the net interest margin which has resulted primarily due to loan principal repayments and loan portfolio amortization. Average loans have decreased by $16.8 million for the quarter ended September 30, 2010 as compared to the same period a year earlier. Additionally higher average balances of overnight liquidity in the form of federal funds sold and interest bearing due from placed added pressure on the margin as these investments yielded, on average, approximately 0.22% for the third quarter and 0.24% for the first nine months of 2010.

Net Interest Income and 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.

Heritage Oaks Bancorp | - 40 -

Management’s Discussion and Analysis

The tables below set forth average balance sheet information, interest income and expense, average yields and rates and net interest income and margin for the three and nine months ended September 30, 2010 and 2009. The average balance of non-accruing loans has been included in loan totals:

	For the three months ending								For the three months ending
	September 30, 2010								September 30, 2009
				Yield/			Income/					Yield/			Income/
(dollars in thousands)	Balance			Rate (4)			Expense		Balance			Rate (4)			Expense
Interest Earning Assets:
Investments with other banks	$	119			1.41	%	$	-	$	119			3.33	%	$	1
Interest bearing due from banks		32,708			0.24	%		20		-			0.00	%		-
Federal funds sold		5,500			0.11	%		1		33,895			0.25	%		21
Investment securities taxable		178,833			3.29	%		1,483		75,563			4.66	%		888
Investment securities non taxable		28,080			4.15	%		294		22,653			4.33	%		247
Loans (1) (2)		697,053			6.21	%		10,908		713,810			5.95	%		10,703
Total interest earning assets		942,293			5.35	%		12,706		846,040			5.56	%		11,860

Allowance for possible loan losses		(21,814	)							(11,969	)
Other assets		88,315								71,976
Total assets	$	1,008,794							$	906,047

Interest Bearing Liabilities:
Interest bearing demand	$	66,885			0.27	%	$	45	$	67,825			0.92	%	$	157
Savings		27,701			0.16	%		11		25,619			0.28	%		18
Money market		286,435			0.90	%		647		209,634			1.52	%		804
Time deposits		229,861			1.72	%		996		219,253			2.32	%		1,284
Brokered money market funds		954			0.83	%		2		2,826			0.70	%		5
Brokered time deposits		100			0.00	%		-		23,426			1.46	%		86
Total interest bearing deposits		611,936			1.10	%		1,701		548,583			1.70	%		2,354
Federal Home Loan Bank borrowing		63,370			0.73	%		116		65,000			0.63	%		103
Junior subordinated debentures		8,248			2.26	%		47		13,403			4.08	%		138
Total borrowed funds		71,618			0.90	%		163		78,403			1.22	%		241
Total interest bearing liabilities		683,554			1.08	%		1,864		626,986			1.64	%		2,595
Non interest bearing demand		180,284								178,293
Total funding		863,838			0.86	%		1,864		805,279			1.28	%		2,595
Other liabilities		10,602								8,490
Total liabilities	$	874,440							$	813,769

Stockholders' Equity:
Preferred stock	$	23,253							$	19,288
Common stock		101,162								48,695
Additional paid in capital		6,881								3,125
Retained earnings		2,728								23,171
Valuation allowance investments		330								(2,001	)
Total stockholders' equity		134,354								92,278
Total liabilities and stockholders' equity	$	1,008,794							$	906,047

Net interest income							$	10,842							$	9,265
Net interest margin (3)					4.56	%							4.34	%

(1)	Nonaccrual loans have been included in total loans.

(2)	Loan fees of $138 and $229 for the three months ending September 30, 2010 and 2009, 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)	Yield / Rate is annualized using actual number of days in period.

Heritage Oaks Bancorp | - 41 -

Management’s Discussion and Analysis

	For the nine months ending								For the nine months ending
	September 30, 2010								September 30, 2009
				Yield/			Income/					Yield/			Income/
(dollars in thousands)	Balance			Rate (4)			Expense		Balance			Rate (4)			Expense
Interest Earning Assets:
Investments with other banks	$	119			1.12	%	$	1	$	119			3.37	%	$	3
Interest bearing due from banks		41,216			0.23	%		72		-			0.00	%		-
Federal funds sold		4,070			0.10	%		3		22,596			0.22	%		38
Investment securities taxable		149,588			3.57	%		3,989		59,614			4.66	%		2,077
Investment securities non taxable		22,956			4.60	%		789		19,763			4.34	%		641
Loans (1) (2)		717,571			6.24	%		33,478		705,187			6.31	%		33,266
Total interest earning assets		935,520			5.48	%		38,332		807,279			5.97	%		36,025

Allowance for possible loan losses		(20,362	)							(10,909	)
Other assets		79,515								70,288
Total assets	$	994,673							$	866,658

Interest Bearing Liabilities:
Interest bearing demand	$	72,987			0.58	%	$	315	$	64,524			0.72	%	$	347
Savings		27,659			0.27	%		55		23,849			0.21	%		38
Money market		276,969			1.07	%		2,214		186,921			1.51	%		2,118
Time deposits		229,917			1.89	%		3,246		182,771			2.49	%		3,400
Brokered money market funds		985			0.68	%		5		25,387			0.72	%		137
Brokered time deposits		2,548			1.84	%		35		29,886			1.67	%		373
Total interest bearing deposits		611,065			1.28	%		5,870		513,338			1.67	%		6,413
Federal funds purchased		-			0.00	%		-		251			1.07	%		2
Securities sold under agreement to repurchase		-			0.00	%		-		870			0.15	%		1
Other secured borrowing		595			4.94	%		22		-			0.00	%		-
Federal Home Loan Bank borrowing		64,451			0.64	%		308		80,982			0.81	%		492
Junior subordinated debentures		11,231			2.42	%		203		13,403			4.42	%		443
Total borrowed funds		76,277			0.93	%		533		95,506			1.31	%		938
Total interest bearing liabilities		687,342			1.25	%		6,403		608,844			1.61	%		7,351
Non interest bearing demand		176,401								162,830
Total funding		863,743			0.99	%		6,403		771,674			1.27	%		7,351
Other liabilities		9,265								8,650
Total liabilities	$	873,008							$	780,324

Stockholders' Equity:
Preferred stock	$	39,325							$	13,741
Common stock		69,499								48,673
Additional paid in capital		4,778								2,504
Retained earnings		8,159								23,166
Valuation allowance investments		(96	)							(1,750	)
Total stockholders' equity		121,665								86,334
Total liabilities and stockholders' equity	$	994,673							$	866,658

Net interest income							$	31,929							$	28,674
Net interest margin (3)					4.56	%							4.75	%

(1)	Nonaccrual loans have been included in total loans.

(2)	Loan fees of $496 and $711 for the nine months ending September 30, 2010 and 2009, 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)	Yield / Rate is annualized using actual number of days in period.

Heritage Oaks Bancorp | - 42 -

California		77-0388249
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

545 12th Street,
Paso Robles, California	93446
(Address of principal offices)	(Zip Code)

				(audited)
	September 30,			December 31,
(dollars in thousands except per share data)	2010			2009

Assets
Cash and due from banks	$	16,681		$	19,342
Interest bearing due from banks		34,936			17,046
Federal funds sold		5,500			4,350
Total cash and cash equivalents		57,117			40,738

Interest bearing deposits with other banks		119			119
Securities available for sale		202,218			121,180
Federal Home Loan Bank stock, at cost		5,395			5,828
Loans held for sale		12,374			9,487
Loans, net of deferred fees of $1,605 and $1,825 and allowance for
loan loss of $21,571 and $14,372 at September 30, 2010 and
December 31, 2009, respectively.		650,706			712,482
Property, premises and equipment, net		6,216			6,779
Deferred tax assets		11,420			10,553
Bank owned life insurance		12,937			12,549
Goodwill		11,049			11,049
Core deposit intangible		2,256			2,642
Other real estate owned		9,031			946
Other assets		9,708			10,825

Total assets	$	990,546		$	945,177

Liabilities
Deposits
Demand, non-interest bearing	$	176,419		$	174,635
Savings, NOW, and money market deposits		384,080			365,602
Time deposits of $100 or more		118,443			117,420
Time deposits under $100		116,682			117,808
Total deposits		795,624			775,465

Short term FHLB borrowing		55,000			65,000
Junior subordinated debentures		8,248			13,403
Other liabilities		9,124			7,558

Total liabilities		867,996			861,426

Commitments and contingencies		-			-

Stockholders' Equity
Series A senior preferred stock, $1,000 per share
stated value, 21,000 shares issued and outstanding		19,701			19,431
Series C preferred stock, $3.25 per share
stated value, 1,189,538 shares issued and outstanding		3,604			-
Common stock, no par value; 100,000,000 shares authorized; issued and
outstanding: 25,082,344 and 7,771,952 as of September 30, 2010 and
December 31, 2009, respectively.		101,140			48,747
Additional paid in capital		6,880			3,242
Retained (deficit) / earnings		(9,187	)		13,407
Accumulated other comprehensive income / (loss), net of (tax) / tax benefit of ($288)
and $752 as of September 30, 2010 and December 31, 2009, respectively.		412			(1,076	)

Total stockholders' equity		122,550			83,751

Total liabilities and stockholders' equity	$	990,546		$	945,177

	For the three months						For the nine months
	ended September 30,						ended September 30,
(dollars in thousands except per share data)	2010			2009			2010			2009

Interest Income
Interest and fees on loans	$	10,908		$	10,703		$	33,478		$	33,266
Interest on investment securities
Mortgage backed securities		1,442			871			3,886			2,044
Obligations of state and political subdivisions		329			247			873			641
Interest on time deposits with other banks		-			1			1			3
Interest on due from Federal Reserve Bank		20			-			72			-
Interest on federal funds sold		1			21			3			38
Interest on other securities		6			17			19			33

Total interest income		12,706			11,860			38,332			36,025

Interest Expense
Interest on savings, NOW and money market deposits		705			984			2,589			2,640
Interest on time deposits in denominations of $100 or more		502			695			1,597			1,870
Interest on time deposits under $100		494			675			1,684			1,903
Other borrowings		163			241			533			938

Total interest expense		1,864			2,595			6,403			7,351

Net interest income before provision for possible loan losses		10,842			9,265			31,929			28,674

Provision for possible loan losses		4,400			9,756			25,700			14,566

Net interest income / (loss) after provision for possible loan losses		6,442			(491	)		6,229			14,108

Non Interest Income
Fees and service charges		581			750			1,820			2,214
Other than temporary impairment (OTTI) losses on investment securities:
Total impairment loss on investment securities		(650	)		-			(650	)		-
Non credit related losses recognized in other comprehensive income		544			-			544			-

Net impairment losses on investment securities		(106	)		-			(106	)		-

Gain on sale of investment securities		807			211			710			333
(Loss) / gain on sale of OREO		(28	)		(200	)		34			(331	)
Gain on sale of furniture fixtures and equipment		-			-			58			-
Gain on sale of SBA loans		-			70			209			70
Gain on extinguishment of debt		-			-			1,700			-
Other		1,253			762			3,281			2,467

Total non interest income		2,507			1,593			7,706			4,753

Non Interest Expenses
Salaries and employee benefits		4,799			3,969			13,528			11,517
Equipment		433			365			1,131			1,066
Occupancy		966			843			2,840			2,521
Reserve for unfunded loan commitments		65			-			65			-
Other		3,611			5,074			10,004			10,586

Total non interest expenses		9,874			10,251			27,568			25,690

Loss before provision for income taxes		(925	)		(9,149	)		(13,633	)		(6,829	)

Income tax expense / (benefit)		9,978			(3,907	)		4,444			(3,196	)

Net loss		(10,903	)		(5,242	)		(18,077	)		(3,633	)

Dividends and accretion on preferred stock		357			352			4,517			613

Net loss applicable to common shareholders	$	(11,260	)	$	(5,594	)	$	(22,594	)	$	(4,246	)

Loss Per Common Share
Basic	$	(0.45	)	$	(0.73	)	$	(1.54	)	$	(0.56	)
Diluted	$	(0.45	)	$	(0.73	)	$	(1.54	)	$	(0.56	)

																	Accumulated
				Common Stock					Additional								Other			Total
	Preferred			Number of					Paid-In		Comprehensive			Retained			Comprehensive			Stockholders'
(dollars in thousands)	Stock			Shares			Amount		Capital		Income			Earnings			Income/(Loss)			Equity
Balance, December 31, 2009	$	19,431			7,771,952		$	48,747	$	3,242				$	13,407		$	(1,076	)	$	83,751

Issuance of 56,160 shares of Series B preferred stock		52,351																			52,351
Discount on Series B preferred stock		(3,456	)							3,456
Conversion of Series B preferred stock to common stock		(52,351	)		17,279,995			52,351													-
Issuance of 1,189,538 shares of Series C preferred stock		3,604																			3,604
Accretion on Series A preferred stock discount		270													(270	)					-
Accretion on Series B preferred stock discount		3,456													(3,456	)					-
Dividends paid on preferred stock															(262	)					(262	)
Accrued dividends and interest on preferred stock															(529	)					(529	)
Exercise of stock options					11,260			42													42
Share-based compensation expense										182											182
Issuance of restricted share awards					26,565
Retirement of restricted share awards					(7,428	)
Comprehensive loss:
Net loss											$	(18,077	)		(18,077	)					(18,077	)
Unrealized security holding gains (net of $1,137 tax)												1,626						1,626			1,626
Reclassification for net gains on investments included in earnings (net of $97 tax)												(138	)					(138	)		(138	)

Total comprehensive loss											$	(16,589	)

Balance, September 30, 2010	$	23,305			25,082,344		$	101,140	$	6,880				$	(9,187	)	$	412		$	122,550

Balance, December 31, 2008	$	-			7,753,078		$	48,649	$	1,055				$	21,420		$	(1,092	)	$	70,032

Issuance of 21,000 shares of Series A Senior preferred stock and common stock warrant		19,152								1,848											21,000
Accretion on Series A preferred stock discount		189													(189	)					-
Dividends paid on preferred stock discount															(424	)					(424	)
Exercise of stock options (including $9 excess tax benefit from exercise of stock options)					10,050			46													46
Share-based compensation expense										269											269
Retirement of restricted share awards					(2,623	)
Comprehensive income:
Net loss											$	(3,633	)		(3,633	)					(3,633	)
Unrealized security holding gains (net of $483 tax)												692						692			692
Reclassification for net gains on investments included in earnings (net of $137 tax)												(196	)					(196	)		(196	)

Total comprehensive loss											$	(3,137	)

Balance, September 30, 2009	$	19,341			7,760,505		$	48,695	$	3,172				$	17,174		$	(596	)	$	87,786

	For the nine month periods
	ended September 30,
(dollars in thousands)	2010			2009

Cash flows from operating activities:
Net loss	$	(18,077	)	$	(3,633	)
Adjustments to reconcile net income to net cash (used) / provided by operating activities:
Depreciation and amortization		967			844
Provision for possible loan losses		25,700			14,566
Amortization of premiums / discounts on investment securities, net		1,206			64
Amortization of intangible assets		386			787
Share-based compensation expense		182			269
Gain on sale of available for sale securities		(710	)		(333	)
Other than temporary impairment		106			-
Gain on extinguishment of debt		(1,700	)		-
(Increase) / decrease in loans held for sale		(2,887	)		161
Net increase in bank owned life insurance		(388	)		(318	)
Increase in deferred tax asset		(12,427	)		(5,017	)
Deferred tax assets valuation allowance adjustment		10,519			-
(Gain) / loss on sale of other real estate owned		(34	)		331
Write-downs on other real estate owned		362			1,449
Increase in other assets		(10,395	)		(8,218	)
Increase in other liabilities		1,037			260
Excess tax benefit related to share-based compensation expense		-			(9	)

NET CASH (USED) / PROVIDED IN OPERATING ACTIVITIES		(6,153	)		1,203

Cash flows from investing activities:
Purchase of securities, available for sale		(105,382	)		(76,600	)
Sale of available for sale securities		8,088			16,040
Maturities and calls of available for sale securities		556			1,138
Proceeds from principal reductions and maturities of available for sale securities		17,627			8,424
Purchase of Federal Home Loan Bank stock		-			(705	)
Redemption of Federal Home Loan Bank stock		433			-
Decrease / (increase) in loans, net		34,266			(38,921	)
Allowance for loan and lease loss recoveries		1,810			30
Purchase of property, premises and equipment, net		(404	)		(1,011	)
Purchase of bank owned life insurance		-			(377	)
Proceeds from sale of other real estate owned		3,099			6,269

NET CASH USED IN INVESTING ACTIVITIES		(39,907	)		(85,713	)

Cash flows from financing activities:
Increase in deposits, net		20,159			150,008
Proceeds from Federal Home Loan Bank borrowing		35,000			75,000
Repayments of Federal Home Loan Bank borrowing		(45,000	)		(119,000	)
Decrease in repurchase agreements		-			(2,796	)
Decrease in junior subordinated debentures		(3,455	)		-
Excess tax benefit related to share-based compensation expense		-			9
Proceeds from exercise of stock options		42			37
Cash dividends paid		(262	)		(424	)
Proceeds from issuance of preferred stock and common stock warrants, net		55,955			21,000

NET CASH PROVIDED BY FINANCING ACTIVITIES		62,439			123,834

Net increase in cash and cash equivalents		16,379			39,324

Cash and cash equivalents, beginning of period		40,738			24,571

Cash and cash equivalents, end of period	$	57,117		$	63,895

Supplemental Cash Flow Disclosures:

Cash Flow information
Interest paid	$	6,519		$	7,433
Income taxes paid	$	5,475		$	460

Non-Cash Flow Information
Change in other valuation allowance for investment securities	$	2,529		$	842
Loans transferred to OREO or foreclosed collateral	$	12,114		$	9,595
Preferred stock dividends declared not paid	$	529		$	-
Accretion of preferred stock discount	$	3,726		$	189
Conversion of preferred stock	$	52,351		$	-

(dollars in thousands)			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
As of September 30, 2010	Cost		Gains		Losses			Value
Obligations of U.S. government agencies and corporations	$	102	$	-	$	(3	)	$	99
Mortgage-backed securities:
Agency		152,042		1,784		(842	)		152,984
Non-agency		15,906		251		(1,849	)		14,308
Obligations of state and political subdivisions		33,359		1,385		(26	)		34,718
Other securities		109		-		-			109

Total	$	201,518	$	3,420	$	(2,720	)	$	202,218

As of December 31, 2009
Obligations of U.S. government agencies	$	108	$	-	$	(4	)	$	104
Mortgage-backed securities:
Agency		78,203		619		(872	)		77,950
Non-agency		21,935		1,184		(2,966	)		20,153
Obligations of state and political subdivisions		22,653		421		(210	)		22,864
Other securities		109		-		-			109

Total	$	123,008	$	2,224	$	(4,052	)	$	121,180

				OTTI Related to
	OTTI Related			All Other			Total
(dollars in thousands)	to Credit Loss			Factors			OTTI
Balance, December 31, 2009	$	372		$	1,584		$	1,956
Additional charges on securities for which OTTI was previously recognized		106			544			650
Realized losses for securities sold		(45	)		(70	)		(115	)

Balance, September 30, 2010	$	433		$	2,058		$	2,491

	Securities In A Loss Position
	For Less Than 12 Months					For 12 Months or More					Total
(dollars in thousands)	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
As of September 30, 2010	Value		Loss			Value		Loss			Value		Loss
Obligations of U.S. government agencies and corporations	$	-	$	-		$	99	$	(3	)	$	99	$	(3	)
Mortgage-backed securities:
Agency		84,468		(841	)		75		(1	)		84,543		(842	)
Non-agency		-		-			9,798		(1,849	)		9,798		(1,849	)
Obligations of state and political subdivisions		2,254		(22	)		150		(4	)		2,404		(26	)

Total	$	86,722	$	(863	)	$	10,122	$	(1,857	)	$	96,844	$	(2,720	)

As of December 31, 2009
Obligations of U.S. government agencies	$	-	$	-		$	104	$	(4	)	$	104	$	(4	)
Mortgage backed securities:
Agency		38,625		(870	)		357		(2	)		38,982		(872	)
Non-agency		-		-			11,618		(2,966	)		11,618		(2,966	)
Obligations of state and political subdivisions		6,012		(210	)		-		-			6,012		(210	)

Total	$	44,637	$	(1,080	)	$	12,079	$	(2,972	)	$	56,716	$	(4,052	)

	For the three months ended						For the nine months ended
	September 30,						September 30,
(dollars in thousands)	2010			2009			2010			2009
Beginning balance	$	59		$	(18	)	$	(19	)	$	(18	)
Additions		-			(11	)		79			(11	)
Disposals		-			-			-			-
Amortization		(1	)		-			(2	)		-

Ending balance	$	58		$	(29	)	$	58		$	(29	)

	For the three months ended				For the nine months ended				For the year ended
	September 30,				September 30,				December 31,
(dollars in thousands)	2010		2009		2010		2009		2009
Balance at beginning of period	$	22,134	$	11,106	$	14,372	$	10,412	$	10,412
Provision expense		4,400		9,756		25,700		14,566		24,066
Loans charged-off:
Residential 1-4 family		316		304		598		304		558
Home equity line of credit		1		-		1		-		-
Commercial real estate		523		41		3,106		41		339
Farmland		-		-		235		-		-
Commercial and industrial		2,530		503		11,348		1,728		5,816
Agriculture		44		1,909		1,253		1,909		2,224
Construction		21		397		1,009		2,218		2,218
Land		1,673		1,801		2,629		2,792		8,886
Other		25		42		132		143		163

Total charge-offs		5,133		4,997		20,311		9,135		20,204

Recoveries of loans previously charged off		170		8		1,810		30		98

Balance at end of period	$	21,571	$	15,873	$	21,571	$	15,873	$	14,372

	For the three months ending,
	September 30, 2010					September 30, 2009
	Net					Net
(dollars in thousands except per share data)	Loss			Shares		Loss			Shares
Net loss	$	(10,903	)			$	(5,242	)
Dividends and accretion on preferred stock		(357	)				(352	)

Net loss applicable to common shareholders	$	(11,260	)			$	(5,594	)

Weighted average shares outstanding					25,004,479					7,699,377

Basic loss per common share	$	(0.45	)			$	(0.73	)

Dilutive effect of share-based compensation awards, common stock warrants, and convertible perpetual preferred stock					-					-

Weighted average diluted shares outstanding					25,004,479					7,699,377

Diluted loss per common share	$	(0.45	)			$	(0.73	)

	For the nine months ending,
	September 30, 2010					September 30, 2009
	Net					Net
(dollars in thousands except per share data)	Loss			Shares		Loss			Shares
Net loss	$	(18,077	)			$	(3,633	)
Dividends and accretion on preferred stock		(4,517	)				(613	)

Net loss applicable to common shareholders	$	(22,594	)			$	(4,246	)

Weighted average shares outstanding					14,719,951					7,694,969

Basic loss per common share	$	(1.54	)			$	(0.56	)

Dilutive effect of share-based compensation awards, common stock warrants, and convertible perpetual preferred stock					-					-

Weighted average diluted shares outstanding					14,719,951					7,694,969

Diluted loss per common share	$	(1.54	)			$	(0.56	)

						Average
				Weighted		Remaining		Total
				Average		Contractual		Intrinsic
	Number of			Exercise		Term		Value
	Shares			Price		(in years)		(in 000's)

Options outstanding, January 1, 2010		440,738		$	9.15
Granted		311,813			3.10
Exercised		(11,260	)		3.73
Forfeited		-			-

Options outstanding, September 30, 2010		741,291		$	6.69		6.33	$	62

Exercisable at September 30, 2010		361,475		$	9.51		2.89	$	18

Options outstanding, January 1, 2009		408,830		$	9.34
Granted		49,741			5.41
Exercised		(10,050	)		3.73
Forfeited		-			-

Options outstanding, September 30, 2009		448,521		$	9.03		4.33	$	484

Exercisable at September 30, 2009		347,172		$	8.92		3.03	$	385

	2010			2009
Expected volatility		43.75	%		37.66	%
Expected term (years)		7			10
Dividend yield		0.00	%		0.00	%
Risk free rate		2.02	%		3.16	%

Weighted-average grant date fair value	$	1.48		$	2.87

	Notional		Cost to Cede		Notional		Cost to Cede
	Amount		or Assume		Amount		or Assume
Off-balance sheet instruments, commitments to extend credit and standby letters of credit	$	158,148	$	1,581	$	169,578	$	1,696

	Fair Value Measurements Using
	Quoted Prices in		Significant Other		Significant
	Active Markets for		Observable		Unobservable
(dollars in thousands)	Identical Assets		Inputs		Inputs		Assets At
As of September 30, 2010	(Level 1)		(Level 2)		(Level 3)		Fair Value
Assets
Obligations of U.S. government agencies	$	-	$	99	$	-	$	99
Mortgage backed securities
Agency		-		152,984		-		152,984
Non-agency		-		14,308		-		14,308
Obligations of state and political subdivisions		-		34,422		296		34,718
Other securities		-		109		-		109

Total assets measured on a recurring basis	$	-	$	201,922	$	296	$	202,218

As of December 31, 2009
Assets
Obligations of U.S. government agencies	$	-	$	104	$	-	$	104
Mortgage backed securities
Agency		-		77,950		-		77,950
Non-agency		-		20,153		-		20,153
Obligations of state and political subdivisions		-		22,127		737		22,864
Other securities		-		109		-		109

Total assets measured on a recurring basis	$	-	$	120,443	$	737	$	121,180

					Purchases,
	Balance as of		Gains		Issuances, and		Sales and			Balance as of
(dollars in thousands)	December 31, 2009		Included in OCI (1)		Settlements		Maturities			September 30, 2010
Obligations of state and political subdivisions	$	737	$	3	$	-	$	(444	)	$	296

	September 30, 2010				December 31, 2009
	Carrying				Carrying
(dollars in thousands)	Amount		Fair Value		Amount		Fair Value
Assets
Cash and cash equivalents	$	57,117	$	57,117	$	40,738	$	40,738
Interest bearing deposits		119		119		119		119
Investments and mortgage-backed securities		202,218		202,218		121,180		121,180
Federal Home Loan Bank stock		5,395		5,395		5,828		5,828
Loans receivable, net of deferred fees and costs		672,277		676,232		726,854		731,045
Loans held for sale		12,374		12,374		9,487		9,487
Bank owned life insurance		12,937		12,937		12,549		12,549
Accrued interest receivable		3,571		3,571		3,639		3,639

Liabilities
Non-interest bearing deposits		176,419		176,419		174,635		174,635
Interest bearing deposits		619,205		620,762		600,830		596,782
Federal Home Loan Bank advances		55,000		55,000		65,000		65,180
Junior subordinated debentures		8,248		7,710		13,403		12,390
Accrued interest payable		474		474		590		590

	Average Balance										Average Yield
	for the three months ending										for the three months ending
	September 30,				Variance						September 30,
(dollars in thousands)	2010		2009		dollar			percentage			2010			2009			Variance
Investments with other banks	$	119	$	119	$	-			0.00	%		1.41	%		3.33	%		-1.92	%
Interest bearing due from banks		32,708		-		32,708			100.00	%		0.24	%		0.00	%		0.24	%
Federal funds sold		5,500		33,895		(28,395	)		-83.77	%		0.11	%		0.25	%		-0.14	%
Investment securities taxable		178,833		75,563		103,270			136.67	%		3.29	%		4.66	%		-1.37	%
Investment securities non taxable		28,080		22,653		5,427			23.96	%		4.15	%		4.33	%		-0.18	%
Loans (1) (2)		697,053		713,810		(16,757	)		-2.35	%		6.21	%		5.95	%		0.26	%

Total interest earning assets	$	942,293	$	846,040	$	96,253			11.38	%		5.35	%		5.56	%		-0.21	%

	Average Balance										Average Rate
	for the three months ending										for the three months ending
	September 30,				Variance						September 30,
(dollars in thousands)	2010		2009		dollar			percentage			2010			2009			Variance
Interest bearing demand	$	66,885	$	67,825	$	(940	)		-1.39	%		0.27	%		0.92	%		-0.65	%
Savings		27,701		25,619		2,082			8.13	%		0.16	%		0.28	%		-0.12	%
Money market		286,435		209,634		76,801			36.64	%		0.90	%		1.52	%		-0.62	%
Time deposits		229,861		219,253		10,608			4.84	%		1.72	%		2.32	%		-0.60	%
Brokered money market funds		954		2,826		(1,872	)		-66.24	%		0.83	%		0.70	%		0.13	%
Brokered time deposits		100		23,426		(23,326	)		-99.57	%		0.00	%		1.46	%		-1.46	%
Federal Home Loan Bank borrowing		63,370		65,000		(1,630	)		-2.51	%		0.73	%		0.63	%		0.10	%
Junior subordinated debentures		8,248		13,403		(5,155	)		-38.46	%		2.26	%		4.08	%		-1.82	%

Total interest bearing liabilities	$	683,554	$	626,986	$	56,568			9.02	%		1.08	%		1.64	%		-0.56	%

	For the three months ended									For the nine months ended
	September 30, 2010 over 2009									September 30, 2010 over 2009
(dollars in thousands)	Volume			Rate			Total			Volume			Rate			Total
Interest Income:
Investments with other banks	$	-		$	(1	)	$	(1	)	$	-		$	(2	)	$	(2	)
Interest bearing due from Federal Reserve		20			-			20			72			-			72
Federal funds sold		(12	)		(8	)		(20	)		(21	)		(14	)		(35	)
Investment securities taxable		919			(324	)		595			2,499			(587	)		1,912
Investment securities non-taxable (2)		87			-			87			162			2			164
Taxable equivalent adjustment (2)		(30	)		(10	)		(40	)		(55	)		39			(16	)
Loans (1)		(254	)		459			205			589			(377	)		212

Net increase / (decrease)		730			116			846			3,246			(939	)		2,307

Interest expense:
Savings, NOW, money market		211			(487	)		(276	)		792			(711	)		81
Time deposits		59			(347	)		(288	)		771			(925	)		(154	)
Brokered funds		(60	)		(29	)		(89	)		(565	)		95			(470	)
Federal funds purchased		-			-			-			(1	)		(1	)		(2	)
Other secured borrowings		-			-			-			22			-			22
Securities sold under agreement to repurchase		-			-			-			(1	)		-			(1	)
Federal Home Loan Bank borrowing		(3	)		16			13			(90	)		(94	)		(184	)
Long term debt		(42	)		(49	)		(91	)		(63	)		(177	)		(240	)

Net increase / (decrease)		165			(896	)		(731	)		865			(1,813	)		(948	)

Total net increase / (decrease)	$	565		$	1,012		$	1,577		$	2,381		$	874		$	3,255

	For the three months ended September 30,
(dollars in thousands)	2010		2009		Variance
Dollar volume	$	45,765	$	38,993		17.4	%
Number of loans		128		99		29.3	%

	For the nine months ended September 30,
(dollars in thousands)	2010		2009		Variance
Dollar volume	$	114,280	$	127,680		-10.5	%
Number of loans		327		377		-13.3	%

	September 30, 2010									Percent of					Single
			Undisbursed		Total Bank		Percent			Bank's Risk			Number		Largest
(dollars in thousands)	Balance		Commitment		Exposure		Composition			Based Capital			of Loans		Loan
Retail	$	39,388	$	2,168	$	41,556		9.1	%		33.5	%		54	$	5,000
Professional		74,919		236		75,155		16.4	%		63.8	%		96		10,000
Hospitality		90,970		220		91,190		19.9	%		77.5	%		47		10,692
Multi-family		20,475		-		20,475		4.5	%		17.4	%		21		3,128
Home equity lines of credit		30,627		20,192		50,819		11.1	%		26.1	%		319		1,680
Residential 1 to 4 family		23,358		839		24,197		5.3	%		19.9	%		72		2,400
Farmland		15,364		353		15,717		3.4	%		13.1	%		24		2,893
Healthcare / medical		17,594		59		17,653		3.9	%		15.0	%		31		2,155
Restaurants		7,013		-		7,013		1.5	%		6.0	%		12		2,541
Commercial		99,301		535		99,836		21.8	%		84.6	%		127		5,000
Other		14,568		172		14,740		3.1	%		12.4	%		25		2,100

Total real estate secured	$	433,577	$	24,774	$	458,351		100.0	%		369.3	%		828	$	47,589

	For the nine months
	ended September 30,
(dollars amounts in thousands)	2010			2009
Balance, beginning of period	$	14,372		$	10,412
Charge-offs:
Real Estate Secured
Multi-family residential		-			-
Residential 1 to 4 family		598			304
Home equity line of credit		1			-
Commercial		3,106			41
Farmland		235			-
Commercial
Commercial and industrial		11,348			1,728
Agriculture		1,253			1,909
Other		-			-
Construction		1,009			2,218
Land		2,629			2,792
Installment loans to individuals		132			-
All other loans		-			143

Total charge-offs		20,311			9,135
Recoveries:
Real Estate Secured
Multi-family residential		-			-
Residential 1 to 4 family		87			9
Home equity line of credit		-			-
Commercial		25			-
Farmland		6			-
Commercial
Commercial and industrial		308			4
Agriculture		73			-
Other		-			-
Construction		27			16
Land		1,272			-
Installment loans to individuals		12			-
All other loans		-			1

Total recoveries		1,810			30

Net charge-offs		18,501			9,105

Provisions for loan losses		25,700			14,566

Balance, end of period	$	21,571		$	15,873

Gross loans, end of period	$	673,882		$	709,867
Net charge-offs to average loans		2.58	%		1.29	%
Allowance for loan losses to total gross loans		3.20	%		2.24	%
Non-performing loans to allowance for loan losses		124.37	%		250.98	%

	Balance		Additions to					Transfers			Returns to						Balance
	December 31,		Non-Accruing		Net			to Foreclosed			Preforming						September 30,
(dollars in thousands)	2009		Balances		Paydowns			Collateral			Status			Charge-offs			2010
Real Estate Secured
Multi-family residential	$	-	$	-	$	-		$	-		$	-		$	-		$	-
Residential 1 to 4 family		1,147		751		(314	)		(235	)		-			(601	)		748
Home equity line of credit		320		-		-			-			-			-			320
Commercial		11,035		17,792		(3,570	)		(5,590	)		(3,305	)		(3,117	)		13,245
Farmland		-		3,810		(286	)		(577	)		-			(235	)		2,712
Commercial
Commercial and industrial		8,429		8,115		(1,072	)		(50	)		(381	)		(11,347	)		3,694
Agriculture		3,172		1,160		(2,348	)		-			-			(1,253	)		731
Other		-		-		-			-			-			-			-
Construction
Single family residential		940		-		(610	)		-			-			(241	)		89
Single family residential - Spec.		683		1,250		-			(538	)		-			(145	)		1,250
Tract		2,215		-		(1,646	)		(363	)		-			(206	)		-
Multi-family		-		900		(4	)		-			-			(417	)		479
Hospitality		-		-		-			-			-			-			-
Commercial		-		980		-			-			-			-			980
Land		10,182		5,221		(5,800	)		(4,726	)		-			(2,633	)		2,244
Installment loans to individuals		47		413		(8	)		(35	)		-			(133	)		284
All other loans		-		-		-			-			-			-			-

Totals	$	38,170	$	40,392	$	(15,658	)	$	(12,114	)	$	(3,686	)	$	(20,328	)	$	26,776

Amount		Interest				Maturity
Borrowed		Rate			Advance Type	Date
$	20,000		0.22	%	Variable	Open
	35,000		0.36	%	Adjustable	1/31/2011

$	55,000		0.31	%

	Regulatory Standard						September 30, 2010						September 30, 2009
	Adequately			Well			Heritage Oaks						Heritage Oaks
Ratio	Capitalized			Capitalized			Bancorp			Bank			Bancorp			Bank
Leverage ratio		4.00	%		5.00	%		11.48	%		10.95	%		9.30	%		8.76	%
Tier I capital to risk weighted assets		4.00	%		6.00	%		15.41	%		14.64	%		10.52	%		9.86	%
Total risk based capital to risk weighted assets		8.00	%		10.00	%		16.68	%		15.91	%		11.78	%		11.12	%

	Rate Shock Scenarios
(dollars in thousands)		-200bp			-100bp		Base				+100bp			+200bp

Net interest income (NII)	$	44,255		$	45,589		$	44,503		$	43,229		$	42,457

$ Change from base	$	(248	)	$	1,086		$	-		$	(1,274	)	$	(2,046	)

% Change from base		-0.56	%		2.44	%		0.00	%		-2.86	%		-4.60	%

(dollars in thousands)
			Percent of
Rate Type	Balance		Total
Variable – daily	$	218,867		32.5	%
Variable other than daily		333,420		49.5	%
Fixed rate		121,596		18.0	%

Total gross loans	$	673,882		100.0	%

(dollars in thousands)
			Percent of
Re-Pricing	Balance		Total
< 1 Year	$	391,763		58.1	%
1-3 Years		191,710		28.5	%
3-5 Years		59,563		8.8	%
> 5 Years		30,846		4.6	%

Total gross loans	$	673,882		100.0	%

	Move in Prime Rate (bps)
(dollars in thousands)		+200		+250		+300		+350
Variable daily	$	887	$	12,042	$	56,092	$	109,426
Variable other than daily		2,370		15,178		62,293		178,740

Cumulative total variable at floor	$	3,257	$	27,220	$	118,385	$	288,166

Exhibit (31.1)		Certification of Chief Executive 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